The economist John Maynard Keynes once made the observation that, “it is better for reputation to fail conventionally than to succeed unconventionally.” This is probably true in many realms. It’s certainly true in the investment world.
As the last twelve months have demonstrated, extreme and unexpected events can and do happen. But analysts whose job it is to make economic forecasts rarely go too far out on a limb when they make predictions. Sure, there are some forecasters who will take a chance with a view that’s far outside the consensus. But most don’t. And it’s for the reason Keynes cited. If you’re a forecaster and you predict that tomorrow will be pretty much like today, that’s a safe bet. But if you forecast something wildly different, you’re more likely to be wrong. And if you are wrong, you’re more likely to look silly and to put your career at risk as well.
As a result, forecasts about the future tend to fall within a narrow range—a range that, with the benefit of hindsight, ends up being far narrower than the range of events that actually happens.
Consider the annual survey of Wall Street analysts by Barron’s. In this survey, Barron’s asks analysts from ten prominent firms to share their market forecasts for the coming year. Just as Keynes would have predicted, these surveys exhibit a narrow clustering of opinion. For example, in December 2020, when Barron’s last polled its analysts, they predicted a total return for the S&P 500 Index of 10.3%—an estimate that is squarely in line with the index’s historical average of 10%. The headline in Barron’s read “The Stock Market Could Gain Another 10% Next Year, Experts Say.” That is like a weatherman in Honolulu predicting that it will be 80 and sunny.
There was some dispersion among the analysts’ opinions, but not much. The most optimistic analyst predicted a gain of about 19%. And the most cautious predicted a gain of 2.5%. Notably, none of the analysts predicted a gain too far from the average, even though the stock market regularly delivers returns that vary widely from the average. In just the past fifteen years, for example, we’ve seen returns that exceeded 30% on two occasions (2013 and 2019). And, of course, the market dropped nearly 40% in 2008. In Keynes’s terms, none of these analysts wanted to risk their reputation by failing unconventionally.
The lesson I draw from this: Be very careful of consensus thinking. It is seldom—if ever—a reliable guide to the future. Of course, this is not a new phenomenon. I mention it now, though, because it feels like today’s investment markets are in the grip of several particularly strong stories that have become the “consensus” view, with a range of opinions that feels too narrow. These include:
- Bonds – Last year, when the Federal Reserve dropped its target interest rate to a range near zero, many investors abandoned bonds. The rates available to bond investors simply became too meager. In addition—and maybe more importantly—investors began to worry that rates were more likely to rise than to decline further. This makes sense: With rates so close to zero, there’s just not a lot of room to go lower. And because bonds generally lose value when rates rise, many have come to see the bond market as a lose-lose proposition. That’s the widely-shared view, but I wouldn’t be so quick to buy this argument. Yes, bonds can lose money. But when bonds lose money, especially if you stick with short- and intermediate-term issues, the losses are typically nowhere near as extreme as the losses that occur in the stock market. And in fact, if you do the math, a slow, steady increase in rates is actually a good thing, on balance, for bond investors. Sure, you might lose a little value in the short term. But at a certain point, you’re better off because you can reinvest maturing bonds at higher rates. It’s for that reason that I still view bonds as a key pillar for most people’s portfolios.
- Stocks – The stock market today, as represented by the S&P 500, is trading at 25 times estimated earnings. That compares to a long-term average just under 17. It’s hard to look at these numbers and not conclude that the market is high. But the narrative that’s taken hold recently reminds me a little bit of the Emperor’s New Clothes. Here’s how the argument goes: The stock market might look like it’s high, but it deserves this new elevated valuation for a reason: because of interest rates. According to the textbook formula for valuing a stock, there should be an inverse relationship between share prices and interest rates. When interest rates are lower, the present value of a company’s future profits rises, and that means its stock price should rise. With rates still so low, the collective belief is that the stock market has entered a new realm—one in which 25 times earnings should no longer be viewed as expensive. But again, I would urge caution in adopting this view. To be clear, I’m not predicting a market correction. But if there’s an opportunity to rebalance your account and take some profits, I wouldn’t hesitate. The market is not like an elevator that only goes up.
- “Special” stocks – Over the past year, a new category of stocks seems to have emerged, led by companies that have benefitted disproportionately from Covid, including Tesla, Zoom, Peloton, Teladoc and the like. When I hear people talk about these stocks, I sometimes hear words like “untouchable.” And Elon Musk is referred to as “a god.” Sure, Tesla is great, but no investment should ever be seen as infallible. That’s how we’ve gotten into trouble before. So I would be careful of this prevailing narrative. Remember that it’s marketers’ job to make you fall in love with a company. Your job as an investor is to remain strictly dispassionate.
- Cash – Last year, a prominent hedge fund manager stated that “cash is trash.” Here’s how this argument goes: If banks are paying less than 1% on cash, while stocks are paying dividends of 1.5%, on average, why hold cash? That may sound convincing, but I wouldn’t buy it. Cash isn’t trash. It only looks that way when the stock market is going up. As you think about your asset allocation, I wouldn’t get hung up on the fact that cash isn’t earning much. The purpose of cash, in my view, isn’t to make money. Its role is entirely different. Cash is there to help carry you through periods when the stock market is down, when your income is interrupted or when you have an unexpected expense. In all of those cases, you’ll be happy to have cash and won’t give a second thought to the rate it’s earning.
- International markets – Over the past ten years, an investment in the domestic stock market has returned more than 250%. Meanwhile, international markets have returned barely 60%. As a result, many have given up on international markets. Here’s how this argument goes: Look around the world, and you’ll be hard pressed to find great companies like Apple, Amazon or Google anywhere else. That’s a testament to American ingenuity. And furthermore, many economies outside the U.S. are downright sluggish, with meager growth and declining populations. For these reasons, there’s no reason to diversify outside the United States. That’s the current narrative. But again, I would be careful. Yes, I think domestic investors should have most of their portfolios in domestic stocks. But historically, global stock markets have ebbed and flowed, and I don’t think we have entered some kind of new realm that will make domestic stocks the permanently better choice.