Podcast Summary
Market forecasting is a challenging endeavor: Despite human tendency to believe in market predictions, history shows they're often inaccurate. Prepare for the unpredictable instead.
Key takeaway from this discussion with Jamie Catherwood on The Investor's Podcast is that market forecasting is a challenging endeavor with a long history of inaccuracies. Despite the human tendency to believe we can predict future market movements, history is filled with examples of forecasts that were off the mark. From the infamous predictions of a permanently high stock market plateau before the 1929 crash to the dismissal of the internet's potential in the 1990s, the record shows that forecasting is a difficult task. As JP Morgan once noted, markets will fluctuate, and no matter how much we'd like to have certainty, there's an inherent uncertainty in the markets. The unexpected, like the COVID-19 pandemic, can completely upend even the most well-crafted forecasts. So, instead of trying to predict the next surprise, it's essential to learn from history and be prepared for the unpredictable.
Biases in Macro Forecasting and Investing: Understanding psychological biases like authority, impatience, recency, do something syndrome, and loss aversion is crucial for making informed investment choices. Studying history can help recognize these biases and make more rational decisions.
While the best chess player in the world may be able to foresee a checkmate, unforeseen events like a chandalier crashing can disrupt even the most well-laid plans. This analogy applies to macro forecasting and investing, where psychological biases like authority, impatience, recency, do something syndrome, and loss aversion can cloud judgment and lead to irrational decisions. Understanding these biases, as outlined in Peter Bevlin's book "Seeking Wisdom," is crucial for making informed investment choices. History, as demonstrated in Joseph de la Vega's 1688 book "Confusion de Confusiones," also plays a vital role in recognizing these biases, as they have persisted for centuries. Despite advancements in technology and investing methods, these biases are likely to continue influencing decision-making in the future. Therefore, studying history can provide valuable insights into human behavior and help investors make more rational choices.
Using history as a compass in the stock market: History can help investors understand patterns and themes that repeat over time, guiding portfolio positioning. Behavioral finance suggests best opportunities arise during uncertain times, but many miss out on initial recovery gains.
While specific outcome forecasting in the stock market, such as predicting a single price target for the S&P 500, is almost impossible with any level of certainty, using history as a compass can provide valuable direction. History can help investors understand patterns and themes that repeat over time, allowing them to position their portfolios accordingly. For instance, during periods of low interest rates, there are often speculative companies that experience rapid growth but ultimately perform poorly. Understanding this pattern can help investors avoid getting swept up in such investments. Moreover, behavioral finance highlights that the best opportunities in the market often arise during uncertain times when people are panicking. However, many investors take a "wait and watch" approach, missing out on the significant gains that come from the initial recovery out of a bear market. The distribution of S&P 500 returns from 1928 to 2022 shows that while the majority of calendar years provide positive returns, the variation in returns from year to year underscores the difficulty of anticipating when the big rally will occur. For example, in 1931, the market fell more than 40%, but in 1932, it rallied more than 40% and was one of the top 5 calendar years in the 95-year period. Therefore, using history as a compass rather than relying on specific price targets can help investors navigate the market more effectively.
Focus on long-term, reliable forecasts: Investors should prioritize broader, long-term forecasts over short-term predictions for market success. Use statistical tools and themes for increased reliability.
Investors should focus on broader, long-term forecasts rather than trying to predict specific outcomes in the short term. According to Joe Consorti, using statistical tools like base rates and expanding the time horizon can help determine the reliability and persistence of forecasting metrics. Trey Lockerbie added that forecasts focusing on general themes moving markets over the long term, such as the AI transformation, are better choices for investors as they have a degree of error built in. Investing involves some level of forecasting, but it's important to differentiate between reliable and nearly impossible to predict forecasts. By focusing on broader, long-term forecasts, investors can ride out the market storms and not miss out on exciting opportunities to generate serious wealth.
Navigating the AI hype cycle: Approach AI innovation with a critical and informed perspective, differentiating between genuine innovators and imitators. Stay informed with financial news through Yahoo Finance for market insights.
During periods of market excitement and innovation, such as the current AI trend, it's important to remember that the cycle has played out many times before. While it's easy to assume that transformative technologies like AI will change everything all at once, it's essential to remember that implementation takes time. The rise of AI has led to an influx of information and expertise, with many becoming "experts" in the field seemingly overnight. However, not all companies in the space are created equal. Some are genuine innovators, while others may be taking advantage of the hype to fleece investors. It's crucial to approach these situations with a critical and informed perspective, taking the time to differentiate between the genuine innovators and the imitators. Additionally, the sponsor's message about staying informed with financial news through Yahoo Finance is a valuable reminder. In today's fast-paced world, staying informed about market trends and news is crucial to making informed decisions. Yahoo Finance provides a comprehensive solution for staying up-to-date on the latest financial news and market trends, making it an indispensable tool for investors.
Investing in AI: Separating Hype from Reality: Investing in AI requires thorough research to distinguish experts from buzzword companies. Historical market concentration on a few large companies can lead to potential risks, but diversification is key.
During periods of exciting innovations, such as the current AI trend, it's crucial for investors to conduct thorough research and differentiate between genuine industry experts and companies that are merely using AI as a buzzword. The history of investing shows that when an industry is hot, it can be challenging to earn adequate returns from companies in that industry due to the influx of investment. While some companies like Nvidia and Tesla have seen great success, it doesn't necessarily mean there will be another Nvidia or Tesla in the 2020s. The market's concentration on a few large companies, known as the "Magnificent Seven," is not unusual historically, but investors should be aware of the potential risks associated with such heavy weighting. As shown in a DFA chart, the US market has consistently been concentrated at the top since the 1930s, with the top 10 stocks accounting for over 25% of the index in many decades.
Historical Fluctuations in Stock Market and Interest Rates: Historically, stock market's largest company and interest rates have fluctuated significantly. Normal interest rates range from 3%-6%, while real interest rates are crucial for investors. Interest rates have rarely been 0% or close to it, except during economic crises. A return to 0% interest rates is unlikely based on historical context.
That historically, both the stock market and interest rates have shown significant fluctuations. At the turn of the 20th century, AT&T held the top spot as the largest stock in the index for four consecutive decades, representing a high level of concentration. Regarding interest rates, historically, normal rates have been between 3% and 6%, with only a few instances of 0% or close to 0% during the Great Depression, the Financial Crisis, and the COVID-19 pandemic. The real interest rate, which accounts for inflation, is typically more important for investors. In the 19th century, the British government's response to wars and debt accumulation led to forced reductions in interest rates, causing outrage among investors. The historical context suggests that a return to 0% interest rates is unlikely.
Unprecedented central bank intervention reshaping economy: Central bank intervention at unprecedented levels, leading to capital misallocation and hindering economic growth. The Fed's role and intervention levels will shape the post-COVID, post-inflation world.
The current economic climate, which has seen historically low interest rates and significant central bank intervention, is unlikely to return to the previous paradigm. Cheap debt has led to capital misallocation and the survival of "zombie companies," hindering creative destruction and economic growth. Central banks, particularly the Fed, have become more involved in the economy than ever before, and their role and intervention levels will be a key factor in navigating the post-COVID, post-inflation world. Central bankers have been involved in economic planning throughout history, but the current level of intervention is unprecedented, and it remains to be seen how the Fed will balance its mandate to control inflation with the need to address social issues. The recent economic anomalies, such as the COVID-19 pandemic and the resulting inflation, have challenged the traditional economic paradigm, and the Fed's response will shape the future of the economy.
Public.com offers a high-yield cash account with an APY of 5.1%: Public.com's high-yield cash account offers a competitive interest rate of 5.1%, making it a strong alternative to other popular financial institutions.
Public.com offers a high-yield cash account with an APY of 5.1%, which is significantly higher than many other popular financial institutions like Robinhood, SoFi, Marcus, Wealthfront, Betterment, Capital One, Ally, Barclays, Bank of America, Chase, Citi, Wells Fargo, Discover, and American Express. This high yield account is a secondary brokerage account with Public Investing, and the funds are automatically deposited into partner banks where they earn a variable interest and are eligible for FDIC insurance. While it may not be the highest interest rate available, it's a strong contender. Additionally, the discussion touched on the issue of bloated debt levels and the historical example of debt restructuring in the US during the early years of the nation when Hamilton took office and had to deal with a dire financial state and massive accumulation of debt. The US government at that time did not have the authority to collect taxes, leading to a lack of revenue, and Hamilton had to write to foreign governments for delays in payments. The historical context highlights the importance of managing debt levels and the potential solutions to bring debt to a more sustainable place.
Alexander Hamilton's creative problem-solving during the US founding: Alexander Hamilton's 'Assumption Plan' successfully converted 98% of US debt in 1790, demonstrating effective financial crisis management despite political challenges.
During the early days of the United States, Alexander Hamilton faced a significant financial crisis and had to convince American debt holders to accept lower interest rates on their bonds in exchange for new, lower-interest securities. This was a politically challenging task as people were wary of a strong central government implementing new taxes or having too much control. Hamilton's solution, known as the "Assumption Plan," was successful in converting 98% of the outstanding debt into new securities, saving the government millions. This restructuring at the founding of our nation serves as an interesting example of creative problem-solving in the face of financial adversity. Fast forward to today, and the efficiency of markets is a topic of ongoing debate. While it may seem that opportunities for undervalued investments have become harder to find, the rise of passive flows and quick access to information through advancements like the telegraph have also played a role. It's a complex issue with no easy answers, but understanding the historical context and the ongoing evolution of markets can help us better navigate the investment landscape.
Markets not completely efficient despite technology: Investors continue to herd into popular stocks, creating biases and inefficiencies, contradicting the belief that technology makes markets extremely efficient.
Despite the introduction of new technologies and access to vast amounts of information throughout history, markets have not become completely efficient and free of mispricings or inefficiencies. Instead, investors have a tendency to herd into the same stocks, creating home country biases and concentrating on popular names. This phenomenon was observed even during the early days of market innovations like the telegraph and ticker, and continues to be prevalent in modern times with platforms like Robinhood. As Cliff Asness pointed out, the belief that technology will make markets extremely efficient is a common misconception, and history shows us that the opposite effect can sometimes occur. John Bogle's quote, "the stock market is a giant distraction to the business of investing," highlights the importance of focusing on fundamental analysis and avoiding the herd mentality to achieve successful long-term investments.
Understanding market complexities and historical contexts: Recognizing market complexities and historical contexts is vital for appreciating investor motivations and shaping financial regulations
Markets are complex systems influenced by a multitude of factors and participants with diverse motivations. For instance, investors can range from passive, price-agnostic buyers to short-term day traders, institutional investors, and individual sellers with personal financial goals. Understanding this complexity is crucial, as it helps us appreciate the dynamic nature of markets and the role of historical context in shaping them. Jamie's recommendation of the book "Tea in the Street" further emphasizes this point. This book delves into the 1930s, a period marked by significant economic turmoil and regulatory change. It showcases how investors navigated this turbulent time, with key players like Joe Kennedy and FDR shaping the modern financial landscape through legislation like the Public Utility Holding Company Act and the creation of the SEC. The book offers valuable insights into the criticisms and debates surrounding these regulatory changes, revealing striking parallels to today's discussions on new legislation and regulation. Overall, the conversation highlights the importance of acknowledging the complexities of markets and their historical contexts to better understand the motivations and actions of various participants.
The 1920s: Few Regulations and Shady Dealings, Leading to Losses for Investors: During the 1920s, lack of regulations led to significant losses for investors. FDR's call for standardized prospectuses and accountability changed the game.
During the 1920s, there were few regulations in place for companies and their prospectuses, leading to shady dealings and smaller exchanges trading unlisted stocks without approval processes. This resulted in significant losses for investors. However, when FDR called for standardized prospectuses and holding directors and company management accountable for the information they provided, it was initially met with resistance. Today, it's hard to imagine not having these standards in place. For those interested in learning more about financial history, Jamie Keech's blog, Investor Amnesia, is a great resource. Subscribing to his newsletter provides quick doses of financial history with interesting charts, stories, and links to historical sources. The website also includes a historical data library, a timeline, and two online courses featuring lectures from industry legends. So, if you enjoyed this conversation, be sure to check it out and follow Jamie on Twitter at @InvestorAmnesia.
