By Tom Bradley
Sports broadcasts usually start with the color commentator providing viewers with the ‘Keys to the Game’. For the Maple Leafs, it might be: (1) contain Crosby, (2) pound the Penguins’ defense and (3) pray. I don’t watch enough sports to be definitive on this, but it seems to me the predictive value of these ‘keys’ is very low. The Leafs could shut down Crosby, pray and still lose. Or they could watch Crosby have a four point night and win (more intense praying perhaps).
Sports is all about entertainment, but this type of short-term analysis is not all that different from what we see in the investment world. When asked, strategists, analysts and portfolio managers are quick to offer predictions about where the market is going this week, next month or the rest of the year, along with a reasoned explanation as to why.
A year ago, the commentators’ keys would have included some mix of: interest rates will stay low; the stock market is range bound; avoid troubled Europe, growth will come from the emerging economies and by all means, stick to dividend stocks.
Unfortunately, the post-game analysis tells quite a different story: in the spring, the market was surprised by a 1% rate rise, stocks went steadily higher, European stocks performed particularly well, companies with emerging markets exposure did poorly and high-yielding REITs and utilities were hit hard.
There’s a reason shorter-term forecasts are regularly off the mark. Markets, like sporting events, have a myriad of variables that feed into the final result and these variables interact in different ways at different times. The market’s spotlight might be on one or two high profile inputs (quantitative easing, budget negotiations in Washington, Chinese consumers), but there are thousands of other variables lurking in the shadows. Some of those variables will turn out to be the unsung rookies and fourth line call-ups that play a big role in the final score.
Also, the front page news may not even be important in determining the short or long-term value of the market. Our recent experience is a good illustration of this. When talking to investors over the last month, the negotiations around the U.S. debt ceiling came up repeatedly and clearly influenced many investment decisions. It’s been my observation that the sitcom in Washington always has an undue influence on investor behavior, despite having little or no long-term impact on market values.
Unreliable forecasts are harmless in the sports arena, and can be for investing too, although there are times when they get in the way of sound decision-making. For example, negative market predictions for the dreaded September/October period might prevent investors from buying a stock that’s trading well below its true value. Or conversely, a rosy forecast from an eminent strategist may entice investors to overpay. In both cases, a guess (I won’t dignify short-term market predictions as being educated guesses) about the market direction ends up overruling long-term fundamentals and valuation. The outcome of the former is random, while the latter has a reasonable chance of success.
It’s also tough to make money off of short-term forecasts because they generally reflect the current consensus. What coach wouldn’t try to contain Sid the Kid and what investor is going to avoid dividends? This tends to mean that the headline variables are already factored into the market. They may prove to be right, but it’s hard to make money off them because the information is already built into security prices.
If the Leafs manage to contain Crosby and pound the Penguins’ blueliners over 10 or more games, they will likely win a few (despite their relative talent deficit). And a portfolio with a focus on dividends and emerging markets may prove to be a winner. But in both cases, these strategies will be totally unreliable in determining what happens in the short term.
You might listen to the ‘Keys to the Game’ for entertainment and to see where the consensus lies, but don’t let them influence your long-term investment decisions. If your money manager or advisor is constantly offering up his or her latest market call, I’d change the channel and look for someone who can help you make investment decisions based on more reliable long-term factors.