A Story About Forecasting

Sometime in late 2015, I was attending our broker dealer’s annual conference, and the keynote speaker was the chief economist from Hilltop Securities.  He got up on stage and started speaking about what he was seeing.

“A lot of people in the world are unhappy” he said, motioning to some slides on the screen behind him. “And as a result, there are two tail events that are both likely to occur.  One, the Brexit vote is going to pass.  And two, Donald Trump is going to become the next President of the United States.” 

There were a few laughs in the audience, and I remember thinking he was crazy.  The UK leaving the European Union still seemed like an impossibility and Trump hadn’t even secured the Republican nomination. There were still ten or so other candidates and all of them looked like more serious contenders to make it through to the general election.    

“Both of these events are going to create a lot of uncertainty” he continued. And the markets do not like uncertainty.  As a financial advisor, you need to be preparing your clients and their portfolios for huge, long-term shocks to the system.”

He then went on to give some very specific investment recommendations that he thought might benefit from this painful scenario.

Fast forward to June 23, 2016. 

On that day the UK voted the leave the European Union and crisis ensued.  The S&P 500 in the US fell by 3.6%.  Shares in London ended the day 3.2% lower.  A broad basket of European stocks was down 6.7%.  Bank stocks across Europe were down 15%.  Japan’s stock market fell by 7.9%. The next day was bad too.   

Turned out this economist was a genius.  The world was falling apart. 

But then it didn’t.  By Jun 30^th, stocks had been rallying for 3 consecutive days and UK stocks closed at their highest levels in 10 months.  The rest of the world rallied as well.  Things weren’t going to be so bad after all. 

Fast forward again to the evening of November 8, 2016.

As election results started coming in, it began to look like the economist was right again. Trump was going to win the whole thing and the markets were going to drop.  As the BBC reported at the time:

US stock futures fell dramatically overnight when Mr. Trump won key swing states, with traders at one point forecasting the Dow Jones to lose 4% or 800 points.

The sell-off hit Asian share markets, leading to them being described as a "sea of red" in early trading, before seeing their losses narrow.

Japan's Nikkei 225 finished 5.4% lower, but the Hang Seng in Hong Kong and the Shanghai Composite - which closed later - lost 2.2% and 0.6% respectively.

But the future markets were wrong. By the next morning, things had already started to turn. Despite initial fears, the S&P 500 finished the trading day up 1.11% and continued going higher from there. Once again, things weren’t going to be so bad after all. 

I am telling this story to remind you that market forecasting is interesting but not important.  There will always be predictions about the future (most will sound scary), but the depth and timing of market movements will always be entirely unknowable.  Given this critical limitation, the only reasonable strategy is to tune out the noise and follow the financial plan.