This year, 2020, will mark my 35th “new year” in the investment and financial planning industry. Over those years, I have reviewed many market forecasts from investment firms that issue them about this time of year. A lot of it is marketing to be sure, but there are some good strategists out there in whom I have a higher level of confidence. Several of those whom I hold in high regard are bullish for 2020.
So, that’s great, right? Well, sort of. These people are smart and do excellent research, but they are human and the truth is no one can forecast the future. Investing is really a process of assessing probabilities and managing risks. And while forecasts may change, there are a lot of things about investing that don’t change. Allow me to provide some perspective on several immutable aspects of investing from 35 years of looking at and formulating market forecasts.
Time and circumstances change but investing “things” don’t change. We know the stock market goes up about 75 percent of the time. We also know there will be severe corrections or bear markets periodically. In retrospect, there are always some telltale signs or indicators that tell us risk is rising or becoming inordinately high (think dot-com bubble in 1999, or excesses in mortgage lending in the mid-2000s). As investors, we have to be constantly aware of these excesses.
Sentiment is important and highly bullish sentiment is usually a negative for the stock market (or any market for that matter). Bullish sentiment reflects high or rising investor confidence and extreme investor confidence is often associated with market tops, like 1999 and 2007. Currently, bullish sentiment is elevated, not extreme, but becoming an increasing concern.
Fundamentals matter. Fundamentals are things like the outlook for corporate profits, valuation, inflation and economic growth. When investing in a rational way, it is important to keep these factors in mind as they have a significant impact on the overall market as well as individual stocks and sectors.
Risk management is paramount. We can look at investing as a “business” and as with any business, managing risk is very important. In investing, we manage risk (reduce portfolio volatility) through asset class diversification, periodic portfolio rebalancing, and portfolio allocation. The goal is to manage and reduce the risk of a major portfolio drawdown under negative market circumstances.
Financial planning can help to reduce investment risk. A comprehensive financial plan can help to lower one’s financial risk in a number of ways: By imparting greater discipline in one’s personal financial management, thereby improving one’s cash flow; by avoiding deviation from a predetermined investment plan which helps reduce the probability of investment mistakes; by increasing one’s potential for a larger estate through disciplined cash flow and investment management.
Bob Toomey, CFA/CFP, is vice president of research at S.R. Schill and Associates on Mercer Island.