Too Many Things Need to Go Right

When I speak with clients about the stock market, I often hear something like, “But aren’t you worried about ___________ [fill in the blank with the day’s most concerning potential catastrophe(s)]?”  

In these conversations, I have to remind them that even if we had a crystal ball and could predict exactly when, and to the extent, these potential catastrophes are realized, we would be unlikely to accurately predict the impact these events would have on the financial markets. 

A few recent examples from the oil markets: 

If an investor knew that Hamas would attack Israel on October 6th and bought oil in anticipation of additional unrest in the Middle East, that strategy would have made sense, but that investor would have lost money after a one-month hold.   

Similarly, if you go back to 2016, there were plenty of people that thought, “A Republican in office is going to be great for the energy companies.  I’m going to buy Exxon stock!”  A reasonable thesis except $10,000 invested in Exxon stock the night Trump was elected was down to around $4,588 by the next Presidential election 4 years later.   

Similarly, if you fast forward to 2020, there were plenty of people that thought, “Democrats are going to do everything in their power to crush energy companies, I need to sell my Exxon stock!”  Investors that sold as a result missed out as Exxon had annualized returns of approximately 55% over the next three years.  $4,588 would have turned into $17,292.89.    

(Note: The links above take you to WSJ, Barron’s, and Bloomberg articles from the relevant time periods, but you don’t need to subscribe to get the point. The headline and first sentence should be sufficient.) 

But You Are Oversimplifying Things! 

Of course I am but I suppose that is the point. Big events don’t happen in isolation. We live in a complex world and pulling one lever moves thousands of others.  Oil prices are impacted by US politics, but they are also impacted by supply, demand, technology, and countless other data points as well.

Trading in Efficient Markets 

Eugene Fama won a Nobel Prize for the Efficient Market Hypothesis which makes the case that publicly traded securities are always correctly priced based on the available information. If this hypothesis is mostly correct – which we think it is – to make money as an active trader, you must be contrarian (going against the consensus view), AND you must be right.   

Knowing when the Fed will raise rates, for example, is helpful, but it isn’t enough to give you a trading advantage if most market participants know the same thing. And even if you know before everyone else, to get a trading advantage, you would also need to know whether investors would see the Fed’s action as putting a dagger through the heart of future inflation causing long rates to go down OR whether the market would see the rate raise as a signal that we would be dealing with higher levels of lingering inflation, which would make longer term yields go up? Getting one right without the other is no help at all.  

So What Should We Do? 

In the words of Jack Bogle, “Don’t just do something, stand there!”  Our job as long-term investors is not to evaluate every current event for a trading idea. Instead, success requires finding the most efficient allocation for accomplishing your financial goals and maintaining the confidence needed to avoid the countless siren songs that seek to pull you off course.