The Future Now
By Martyn Page - Worldwide Financial Planning's Investment Director
December 21, 2022
THIS is the time when fund managers give their stockmarket predictions for the year ahead. But which year? We’ve already missed the Celtic new year – that was Halloween. China’s new year falls on January 22 followed by Iran on March 20. For Thailand it’s April 13, while the Islamic New Year commences on July 18, the Academic new year begins on September 1 and the Jewish one falls on September 15.
For Aborigines there is no such thing as New Year. They don’t have a stockmarket, either. For these indigenous Australians, seasons are viewed as components of cycles. In the Tiwi islands just north of Darwin there are three major seasons but these contain 13 overlapping, quite precisely defined seasons within.
If you think that sounds a little bonkers then spare a thought for our own New Year. The first of January was legislated into existence by Julius Caesar to make the calendar work properly and named in honour of the god Janus whose two faces allowed him to look back at the past and forward into the future.
In today’s financial world, it is the time for reviewing 2022 and making forecasts for 2023. But not many people make all their investments on January 2 with a 12-month planning horizon. Indeed, company annual reporting years don’t always plan to the calendar year either. They can end in December, March, June, August, September and other months.
So why do we do want annual predictions? Newspapers want them as they provide cheap, topical filler when politicians are in recess. Giant investment banks make them in order to generate trading. Fund management groups provide predictions to discharge their supposed duty as financial seers, satisfy clients, oblige journalists and gain publicity. Some fund groups refuse to provide them, others simply add 10 per cent onto whatever the current index level is at the time when they are asked – usually that’s in late November.
Humans crave certainty. We all want to know the future now; we want to see it on the screen. Beneath all this lies fear of the unknown. But by definition, the unknown cannot be known. For private investors then, the mental trick is to accept that it’s unknown. Accepting this puts you one step ahead of the game.
When you buy a share in a company, either individually or via an investment fund, you are not buying its past performance; you are buying a slice of its future profits. As it happens, financial analysts are actually quite good at estimating what a company’s profits will be a year hence. They do get some help here, as many companies publicly state what profit they expect to make in the year ahead. Furthermore, over the very long term, shares tend to be worth the accumulated value of all their earnings. So far, so good.
However, what analysts are incapable of doing is estimating what price a share will be in twelve months’ time. This is because the market may decide that next year’s profits are worth paying a price multiple of eleven times, seven times or maybe nineteen times the expected earnings per share forecast by analysts. And the market may change its mind to a lesser or greater extent several times during the year.
Since a stockmarket index such as the FTSE-100 Index is just a reflection of the price of each constituent, you won’t be surprised to learn that professional forecasters have also been unable to predict where a stockmarket index will end up over a short term on a specific date such as New Year’s Eve 2023. That’s because the price multiple (the P/E) placed on the shares is much more volatile than are the underlying profits.
Last year, a study of the annual returns of America’s S&P 500 Index showed that while the annual average rise between 1928 and 2021 has been 8 per cent, the Index has rarely gone up by about the average amount in any one given year. Remarkably, in only six out of the last ninety four years has the annual S&P 500 Index gain actually been between 5 per cent and 10 per cent*.
In fact, both above-average and below-average returns occur more frequently than the average outcome. It looks like 2022 will continue this pattern as, barring an extreme year-end rally, it will end up in the below-average bucket too.
Put another way, even if you knew the exact earnings every company would make in the year ahead, it would tell you virtually nothing about how the market was going to behave over the following 12 months. But, as we said above, the mental trick is to accept that the near-term is unknown. Unlike giant financial institutions with their short-term targets and quarterly reporting, you can be patient, you can ride things out. This is one of the few advantages the small private investor has over the professionals.
All of the above was said much more pithily in a quote you will most likely have read before, ‘In the short run, the market is a voting machine but in the long run it is a weighing machine.’ What Warren Buffett, meant was that in the short run the price of a company’s share reflects how buyers and sellers react almost entirely to economic data, news, media reports, investor sentiment, how other buyers and sellers react and exogenous events (Covid, war, a sharp change in interest rates etc), whereas in the long run, the market value of a company will reflect the quality of a business and its fundamental profitability.
When companies set themselves goals to grow their business, they typically set targets to be achieved over five years. Realistically, that’s how long it takes to effect change. Investing is therefore something to be done for the long term. Take the rough with the smooth, ignore the daily noise and always remember that it is time in the market that counts, not timing.
*Bloomberg, S&P 500 Index price series from January 1928 to November 2021. Janus Henderson.
