Forecasting May be Fun, But Acting on Probabilities is Critical

By David B. Armstrong, CFA | Mar 25, 2021 | Invest My Wealth, Weekly Market Commentary

I’ve written about forecasting in the past. Specifically, how forecasting is relatively useless in the context of creating or changing an investment portfolio. No one has a crystal ball, and no one knows what’s going to happen next.

It only takes one look at the 2020 forecasts from January of last year to see that no one was predicting a global pandemic.

Even though I find forecasting to be of little use for investing, it’s hard for me to wake up every day and say I have no interest in thinking about what will happen next.

So, while I generally eschew forecasting, I do spend a great deal of time talking about using probabilities to align portfolios with long-term returns…along with a dash of patience and a few sprinkles of discipline.

On that note, did you know that we launched our podcast? Yup, and in our most recent episode, Jessica, Dean, and I engage in a conversation about how to think about probabilities as an investor. Catch it here, and be sure to subscribe, so you get alerted to new episodes dropping.   

Anyway…forecasting and probabilities are separated by a line which at times can seem to be merely a millimeter thick. Still, there are benefits to talking about probabilities and how they relate to optimism about long-term investing.

So here are some of my thoughts in the context of assessing the probability of the equity markets doing well over the next 12-18 months.

Side note – Listen to episode two of our Off The Wall Podcast for our Portfolio Manager Erin Hay’s thoughts on the Wall of Worry.

These points provide us with the optimism to keep guiding investors toward a higher allocation to equities than fixed income, while using cash to provide a hedge and margin of safety for the inevitable sell-off that will come at some (unknown) point of time in the future.

• We have a generally favorable and positive outlook for a continued consumer recovery and an increase in travel, social outings, and general “consumer mobility” as we progress through the vaccine cycle. Just today, I read we are issuing 3 million vaccines per day.
• We think there’s a fantastic backdrop for the equity markets to perform well over the next 12-18 months. The business cycle seems to be expanding and COVID-19 related economic risks continue to diminish.
• We think we’ll see earnings recover as the economy continues to grow.
• There’s over $30 trillion of global stimulus that has already been injected into the system and adding the additional $1.9 trillion US stimulus will create a lot of tailwind for the equity market.
• Coupling the above with the ongoing, easy monetary policy that will continue to lower the unemployment rate and incentivize another home refinancing wave, indicates that the backdrop for equities over the next 12-18 months isn’t going to be hurting.
• There’s an incredibly high amount of household liquidity right now. That liquidity can be seen in the record amount of cash that’s being held in bank accounts. According to a Goldman Sachs report, there was $11 trillion in savings accounts and $4.8 trillion in checking accounts around the end of February. That’s a lot of cash sitting around to be spent or invested–both of which add to the positive backdrop for equity markets.
• It’s no secret that there’s a considerable wealth effect taking place right now. I’ve seen some estimates in the range of $124 trillion net worth, which is a function of rising values in home prices, the stock market, 401K plans, and a lower consumption rate. Some estimates show that consumption was lower in 2020 by over $300 billion, with gasoline savings accounting for 1/3 of that amount.
• The consumer looks healthy. Debt servicing is at a 40-year low, and we see historically low delinquency rates on consumer loans. Mortgage rates had declined to below 3% earlier this year and are currently back at 3%. Keep in mind that the average mortgage rate in 2019 was about 4%, and the 2018 average was 4.8%. When you combine low rates with rising house values, you can expect more spending from the consumer.
• The labor market is healing. There has been a steady decline in the unemployment rate. The average hours being worked over the typical workweek have been increasing, and there’s still the possibility that we’ll see a higher minimum wage. While it can be argued to be detrimental to the economy, it can’t be ignored that a higher minimum wage will put more money into consumers’ pockets.
• It’s doesn’t come as a shock that millennials are a massive bubble in the total population. They’re getting to an age where they’ll become a force to reckon with in the housing market…that’s on top of all the housing momentum we’re already seeing.

I don’t think a day goes by where the press doesn’t highlight something pessimistic. Still, if you look at how far we’ve come from a standard of living perspective in the past 100 years and overlay that on the equity markets’ long-term performance, it’s clear that optimism wins the day.

As for the probabilities, well, they’re in investors’ favor.  While each day is essentially a 50/50 chance of the market being up, the odds of the market being up over one year is about 68% and about 88% over ten years.

Which isn’t too bad.

Forecasting is fun, but acting on the probabilities is more critical to an investor. Be invested with a purpose and protect with cash because cash keeps you from selling when a market correction comes around.

Because it will.

Keep looking forward,

Catch episodes 1-3 from our Off the Wall Podcast here!

 

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