The time of year where it is tradition to reflect on the last twelve months with the benefit of hindsight is upon us. It’s also traditionally the moment when experts make their calls for the twelve ahead, picking out the themes they expect to dominate and influence financial markets.
The problem with round-ups and explanations of things that have already happened is that they are relatively easy to put together in a way that sounds clever and perfectly obvious but not very useful. That ship has sailed.
The problem with predictions for the year ahead is that they would be extremely useful if we could rely on them with any level of certainty but we can’t because they are rarely accurate. But that’s ok because by the time the year ends nobody really remembers all of the wrong predictions made at the start of the year. Of course, those who made any that turned out to be right will draw attention to those hits. All the misses are forgotten about.
Human psychology also dictates that there tends to be more coverage of optimistic forecasts and positives than negative forecasts and problems, often written off as doom-mongering. Until negative outcomes come to pass and then we flip a switch and only see doom and gloom. It’s this seemingly inescapable herd psychology that leads to the bull and bear cycles that define the history of financial markets.
We can be as certain as possible that bull cycles in financial markets will lead to over-optimism and unrealistically high average valuations. And we can be just as certain bear markets will see the inverse and mass pessimism will lead to assets being under-valued before the cycle turns again.
However, while the big picture of market cycles is highly predictable, their timing isn’t. Investors all know a bull market will eventually conclude with a bear market but most still get burned when the cycle turns because gains are often most impressive just before a crash. Very few investors are willing to risk missing out on potential returns others are banking, on paper, even if it increases the risk of giving up part of the gains that could have already been locked in.
FOMO during a bull market is as strong a factor as there is when it comes to investing and the most successful investors are usually those able to control its influence on their decisions. During a bear market, it is fear that becomes the dominant influence. Investors that have already recently suffered losses are often afraid of more.
Why were 2022 forecasts so wrong?
At the end of 2021, stock markets had experienced a month of sharp declines as inflation surged. But the second half of December saw a bounceback as a majority of economists and stock market analysts predicted inflation would be tamed as supply chain disruptions were overcome and consumers started spending more on services and less on goods in a post-pandemic economic environment. It’s not that there weren’t analysts warning that high levels of inflation might prove more stubborn but they were a clear minority.
Of course, analysts can point to Russia’s invasion of Ukraine in late February of last year as the Black Swan event that shattered predictions inflation would be brought under control. The claim has justification with sanctions brought against Russia by the West and the general disruption to exports out of both countries leading to spikes in the price of energy, food and many industrial commodities from metals to fertilisers.
If Russia had not invaded its neighbour, it is almost certain that inflation would have been significantly lower last year than it was, hitting levels not seen in the major developed economies in almost half a century.
Source: Financial Times
But there was also a failure to look beyond traditional models for predicting inflation that did not take into account the unique circumstances of the Covid-19 pandemic and the unprecedented levels of fiscal stimulus it unleashed. Too little attention was also paid to China’s zero-Covid policy and the ongoing impact that would have on global supply chains.
Most eyes in the West were focused on the end of pandemic restrictions there and again ignored the recent evidence of how fragile and China-centric globalisation had made supply chains.
Should we put faith in forecasts for 2023?
Economists and market analysts are again forecasting falling inflation for 2023 but should investors put any more faith in those predictions than they should have a year ago? Roughly the same arguments presented last year are being recycled again this year. China’s dropping of its zero-Covid policy, and some reduction to their exposure to China, is seen as likely to result in supply chain issues receding.
The fact the predictions are simply being made again one year later could also increase their chances of coming to pass this time. Inflation won’t stay elevated forever so the longer it remains high, the greater the chance of it dropping in the not-so-distant future.
Forecasters are also being more conservative and even those who were sceptical of a quick return to normal levels of inflation a year ago, like Harvard economist Jason Furman, believe there are better arguments for inflation falling this year. However, expectations that inflation will drop to around 3% in the USA and around 4% in the UK by the end of the year are based on present information.
Any new major setback such as a significant escalation of Russia’s war in Ukraine or further supply chain disruption would be expected to keep inflation higher for longer. The impact of high levels of inflation in 2021 and 2022, and interest rate rises, will also likely be felt more keenly in 2023 with business and personal cash reserves built up over the good times depleted. Recession is likely, which will bring new challenges.
Invest for uncertainty
Financial markets are always very hard to predict, especially with any accuracy of timing. Current circumstances make it even harder to call what might happen over the year ahead than normal. As such, investors probably shouldn’t make decisions whose outcome will be determined by what happens over the next year.
Investment decisions should, more than ever, be made with long-term trends in mind. Be prepared for losses in 2023 and make sure you are in a position to ignore them, confident in the underlying qualities that should mean assets will prosper when the economic and market cycles turn. Make sure, whenever possible, to have enough cash on hand to be able to do so.
Be optimistic – the cycle will turn: but don’t expect to get your timing right
Whatever happens to markets in 2023, they will eventually return to health. A recovery will hopefully take hold at some point this year but if it doesn’t, try to be in a position that will allow you to see that as a continuing opportunity, rather than a problem. The further asset prices decline, and the longer they remain depressed, the bigger the window of opportunity for investors to buy them for good value.
2023 could well be the perfect year to apply the famous Warren Buffet quote to be “fearful when others are greedy, and greedy when others are fearful.”
If you are investing in a well-diversified range of high-quality assets whose future ability to maintain or improve on current revenue generation looks strong, you should be able to safely ignore the fact there is a high chance many of the forecasts made for the year ahead will turn out to be wrong.
Be an optimist when it comes to the global economy. Just avoid expecting to get the timing right or worrying about leaving returns on the table if you don’t. Think big picture, long term and ignore any forecasts timeboxed by the label “2023”, and your investments should be just fine.
