Our prediction for the year ahead? You will be wrong

The information in this article is market commentary only and reflects Lincoln's views and beliefs at the time of preparation, which are subject to change without notice. To obtain up-to-date information, please contact us.

The start of a new financial year will have many hypothesising about the future from an investment perspective, where the opportunities are in the market and of course, what investors should be cautious about.

It will also be a time when the Australian Fund Manager annual performance leagues table is rolled out. This year, the headline observation will most likely be the alarming number of professional active managers that have underperformed the market over the past 12 months, an intriguing paradox given many will be asked for their view as to where things are headed over the year to come.

In fact, many have taken quite aggressively to espousing the virtues of their views on not only the investing world, but also in areas outside of their realm of responsibilities. Their opinions on the macro economy, key sectors and our own personal well-being are often reported on, supported by logic, facts, observations and figures for validation.

Taking a ‘view’ on the world from a top-down perspective and then translating it to how we should be managing our portfolio is fraught with danger, because the minute anyone thinks the market is rational and predictable is the point where they are most at risk at getting hurt, badly. Worse still, you don’t have to be wrong for long. The market moves quickly, and a short misstep can become a big long-term drag due to the power of compounding.

The analyst industry has been built around the idea that we can get ahead of the curve and profit from the inefficiency in the market by forecasting what will likely occur in the future. But predicting the future is a futile task that often means they get it wrong.

This failure to ‘get it right’ has led to the popularity of Exchange Traded Funds (ETF) that are constructed by algorithms to track an index at very little cost. It is our opinion the reason why the market for ETFs has grown significantly over the last few years is not because they perform so well, but rather it is because most active managers have done so poorly.

Sure, there are times of over exuberance or over pessimism in the market, but what can’t be denied is that the price today, is what the price is. Therefore, investing in an index will generate a return in line with the market which means in theory you too will never be wrong.

Over the last year we have seen well-constructed arguments suggesting that stock prices are too high relative to valuations, that bond yields have inverted indicating a recession, that election outcomes will be bad for investors, that property prices will collapse, that tech bubbles are re-emerging, and that trade wars and geopolitical issues will impact global growth. Yet despite all these concerns, share prices rose throughout the year. The perennial justification is that the market is forward looking and therefore expectations need to be adjusted with the future in mind. Fortunately, in this instance, past performance is not a reliable indicator of future performance.

But no one knows what will happen in the future, and even if you happen to flip the coin and get that right, how it translates to your share portfolios can often be a greater mystery. So, this financial year with our market fast approaching all-time highs, concentrate on doing two things that from our experience, will differentiate a successful investor from a poor one:

  1. Develop a robust bottom-up investment framework for making informed and confident decisions. Base your decisions on facts that you have a high degree of certainty over, not simply forecasts, and identify stocks to hold that exemplify quality factors.
  2. Block out the noisy market nonsense and avoid top-down investment decision making based on macro factors. Remove the subjectivity from your stock selection process, focusing on companies that meet your growth and/or income objective and tolerance to risk. If they meet your criteria, then they are in. When they fail, then out they go.

It is important to stress that we do not suggest investors be frivolous with their share investments and forget about managing portfolio risk. It is prudent that you maintain an exposure to the share market relative to your stage of life, net wealth and tolerance to risk. Sticking your head in the sand and relying on luck is not a successful strategy long-term.

That is why following a strong year of capital gains, we recommend you (or with your financial advisor) proactively review your share investment portfolio, take profits off the table if necessary, reallocate capital to new opportunities or continue to build a war chest of cash to seize future opportunities when they occur. At least with this last point we can all be certain.

ELIO D’AMATO (@Elio_DAmato)

Elio D’Amato is the Executive Director at Lincoln indicators, a leading boutique fund manager and creator of Stock Doctor the complete share market research platform.  www.lincolnindicators.com.au