Investors can find themselves fretting about what current events might mean for stock market returns. Often fueling their anxiety are media headlines implying that “X” leads to “Y”. This tends to lead to implicit questions along the lines of: “Isn’t it obvious that (this event) will mean (that outcome) for markets?”
One recent supposed foreboding sign for future stock returns has been the inversion of yield curves in Australia, New Zealand and the US. Another has been rising government debt and its implications. Overlaying that is talk of what a recession would mean for stocks. In New Zealand, for instance, headlines abound about the economy slipping into its second recession in 18 months.
Of course, a relationship between “X” and “Y” can seem intuitively reasonable and even a good story. However, an objective look at actual data tends to cast doubt on the validity of such implied relationships. For example, there is little evidence that yield curve inversions, government debt levels or recessions are reliable indicators of when to get in or out of stocks or what these events might mean for future returns.
This is because market prices already reflect current information, as well as the aggregate expectations of all market participants about the myriad of variables that can move markets, such as economic data, government policy, interest rates or earnings news.
If news evolves in ways that markets don’t expect, prices may change. But unless you can forecast news and do so consistently, it is hard to profit from this. And even that doesn’t take account of the costs of selling and buying or the opportunity cost of being out of the market.
Of course, when negative events occur or when headlines predict worse to come, investors’ thoughts may turn to market timing. This is sold as a strategy to avoid short-term uncertainty without missing out on long-term gains. But that misses the very purpose of a long-term plan, which is to take account of a wide range of possibilities to improve the odds of you reaching your goals. In any case, all the evidence suggests timing strategies are not effective.
So next time you hear a pundit publicly declare that [fill in the blank] means [fill in the blank] for markets, ask if this is so “obvious” wouldn’t it be reflected in prices? And then remind yourself that for long-term investors it is more helpful to plan for what can happen, rather than trying to predict what will happen.
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