If you ask an “investment expert” what growth rate to expect on your stock portfolio over the next 10 years, he or she could with great confidence and authority give you an answer. Knowing market history, they might predict 10 percent since that is about the average return on US stocks over the last 90 years. Ten percent is a reasonable answer, and it is almost certainly the wrong answer. If you bet your retirement on that logical but almost certainly wrong answer, it could end up very bad for the future you.
The more certain an investment expert is about his market prediction, the more certain you can be that he is either an amateur or dishonest. The true professional will give you a much less satisfying but accurate answer along the lines of “I have no idea”. Why? Because financial markets are complex adaptive systems, which means their very nature is unpredictability. Consider that markets are made up of millions of human participants like buyers, sellers, corporate managers, and government officials—each exerting some bit of influence on market prices. Sometimes that influence can spark massive responses out of nowhere. Consider corruption at Enron or innovation at Apple—two examples of rare and unexpected market movers. One powerful government official could warp world economies by nullifying a trade pact. Other variables move markets daily like interest rates, Presidential tweets, volcanos, terrorists, Amazon’s HQ2 decision, inflation, riots in Greece, and Tom Brady’s hand injury. Volatility in any of those variables—all of which are unpredictable or even random—move market prices. That’s complex.
It gets infinitely more complex when you add in the adaptive part. Each actor and variable adapts unpredictably to changes in the other variables or actors. Sometimes bad news for stocks means gold rises, but sometimes not—it depends on the reaction of many variables. We just can’t see around the corner to know how people will react to unpredictable and sometimes never before seen circumstances. Read some of the predictions surfacing about Cryptocurrencies. Can anyone be certain how to play that market over the long term without accurately guessing what firms will be winners, how governments will interfere, or what competing technologies will pop up? The variable outcomes are endless. When the car was invented, no one predicted it would lead to suburbs, minivans and Wal-Mart. When Apple invented the iPhone, no one predicted Uber or AirBnB. Even the most informed inside players equipped with powerful supercomputers are humbled by complex adaptive systems.
Investment performance charts always have a warning about using past results to predict the future—it’s not a warning you should ignore. When it comes to investing, the past looks very different than the present and the future is truly unknown. Over the last few decades we have seen the rise of Federal Reserve monetary policy, the introduction of the 401k adding millions of traders to the market, high frequency trading, mutual funds, ETFs, the rise of Japan, the rise of China, the end of the cold war, the baby boomer generation retiring, the explosion of computing power, artificial intelligence, 30 years of falling interest rates, 9-11, and on and on. The change is accelerating, so the complexity will just be magnified.
When you hear confident market predictions, no matter how passionate and elegantly described, be certain that you are listening to someone who hasn’t yet been humbled by complexity (an amateur), or someone who does understand unpredictability but doesn’t care because they have a dishonest agenda.
The good news is that once you get past trying to outsmart the markets, there’s plenty of wisdom out there on how to tame the complexity and win the game in the long run. That’s next week’s topic.