Fortune Telling: Why Everyday Investors Need A Crystal Ball

I read a lot, but I learned long ago that no amount of reading equipped me to accurately predict the future…of anything. The world out there is just too random – with too many variables at play – making it extremely difficult to predict with accuracy how current economic trends might ultimately play out. Can you imagine how different things would be with a crystal ball? Since I’m not a credentialed financial advisor, the answers (observations) I give are strictly my opinion.

Unknown Unknowns

Most assuredly, investment “opportunities” are difficult to predict. Without a crystal ball, it’s impossible to peek around life’s many corners – to foretell with accuracy the unknown “unknowns” that lurk out there. And without knowing the unknowns, investors must employ various methods of risk reduction to avoid the inevitable pitfalls of investing.

These unknown unknowns are why I avoid investing in individual stocks…why I gravitated toward mutual funds, particularly index funds, back in the early 1980s. It’s hard enough to ascertain where a particular stock is heading and even more difficult to know what the overall economy has in store.

Covid-19 Unknowns

Recall if you will, the series of major events that began to emerge in early 2020 – the unsettling onset of Covid-19. Do you recall anyone predicting it - and its dramatic short-term impact on the stock market? Yes, coronaviruses of one sort or another were known to exist back then and there were occasional prognostications that a global pandemic was lurking on some distant horizon. But no one that I recall suggested that such a disaster was on our doorstep, ready to spin out of control in early 2020. And I don’t recall anyone warning investors about those other related unknown unknowns that followed.

Did anyone predict, even mention, our government’s range of extreme responses to Covid? The massive economic shutdown followed by various forms of stimuli that would lead to 2022’s devastating inflationary environment – and the Federal Reserve’s erratic (transitory) 2021 response to addressing it? I don’t recall anyone predicting those events. And when the Fed finally did respond, did anyone suggest it would be in such a dramatic fashion?

Hindsight is 2020

In short, how could you or I anticipate such a series of unknown unknowns: the pandemic itself; the government’s reaction to it; the Fed’s “transitional” delay in dealing with the political class’s more than generous stimulus overreach, which led to an inflationary spiral, whose suppression might yet – or might not – lead to a recession.

With the clarity of hindsight, the federal government’s response to Covid-19 utilizing aggressive stimulus payments and other programs led to an inflationary spike, and yes, some foresaw this possible reaction, but who could have predicted the hesitancy of the Federal Reserve’s response? And then, after over-cautious hesitancy, what did they do? They started hiking rates dramatically.

And then, Mr. Putin made his unknown unknown known when he invaded Ukraine in early 2022. And, because Russia is a major natural gas exporter to Europe and crude worldwide, unexpected energy forces were unleased. And, because Ukraine is a key grain producer, commodity prices spiked unexpectedly, adding to the world’s inflation problem. Not to be outdone in the world of unknown unknowns, China's zero Covid policy, which shut down cities and factories, contributed to worldwide inflation through product shortages.

Educated Guesstimates

This series of unknown unknowns was unique, as most are, but not unusual. The unexpected happens all the time in life. No amount of reading or research would have helped an investor – skilled or not – anticipate the tangled web of Covid-19 unknown unknowns.

So, where does this leave the average investor? Above all, one must accept the investment world for what it is. Economics is not an exact science. There are simply too many variables affecting economic activity. That’s not to say that investment research isn’t necessary or helpful. But one must employ a realistic perspective when studying investment data. Alone, bits of data are seldom definitive - they must be viewed in terms of ranges and probabilities and certainly not in absolute terms. Deal with data as approximations that collectively help investors make educated guesses, not guaranteed predictions.

Expect the Unexpected

Also, avoid making major changes all at once. For example, utilize dollar-cost-averaging instead of rushing into action when investing. In changing asset allocation, paying down debt, or starting a new company, implement important decisions in measured steps. Grow and absorb…grow and absorb. Look for ways to hedge…to diversify…to split the difference on major decisions. You’ll be glad you did if things turn out quite differently than expected.

And because markets are…alas…very unpredictable, develop a flexible plan – one that works in both Bull and Bear markets…in good times and bad. I often mention the importance of consistency in following one’s investment plan. But don’t be consistent to the point of bullheadedness. Be balanced in your approach. Avoid cognitive dissonance (a term describing the mental discomfort resulting from holding two beliefs or values incompatible with each other). Listen carefully to contrary opinions, and then make up your mind.

Because the marketplace is influenced by diverse factors, Look at news and data points as puzzle pieces. At first glance, an evolving movement is often brainteasing. But the more pieces one collects, and the more time one spends thinking about how the pieces might fit together, the better informed one is. And remember, there is rarely a perfect investment puzzle. Investors seldom have all the pieces prior to making an investment decision.

Housing Bubble Update

Mortgage rates are dancing around 7%. For those of us who’ve been around a while, there's nothing unusual about mortgage rates this high. But coming from a recent environment of historic low rates, today’s players in the housing market are predictably anxious…with reason. The recent explosion of domestic home valuations coupled with suddenly high rates has propelled today’s monthly mortgage payments into whole new brackets. Considering current income levels relative to the current high cost of homes, it's more expensive to buy a home now than at the height of the early 2000s housing bubble.

This so-called “affordability crunch” across the spectrum of home prices has eliminated potential buyers right and left, causing housing analysts to downgrade home price outlooks. For example, back in August, Moody’s Analytics expected home prices to adjust downward between 0% and 5%. In September, they tweaked the downgrade to 5% to 10%. Today, they’re stuck at the top of that range, assuming no recession. Should future Fed rate increases shift the economy into a recession, Moody anticipates a potential peak-to-trough price decline of between 15% to 20%...mindful of the 27% price decline between 2006 and 2012. But keep in mind the possible unknown unknowns.

In short, affordability has evaporated and with it the demand for housing…despite a supply/demand imbalance. Home values surged during the pandemic years. Then came inflation due to government-induced liquidity and the resultant battle to contain it through Fed rate increases that immediately impacted mortgage rates to the upside. This combination of events has created a willingness on the part of motivated sellers to reduce asking prices…despite the presence of a supply/demand disequilibrium (i.e., a shortage of homes for sale). In the absence of buyers, builders simply aren’t willing to build sufficient new homes to rebalance the supply/demand equation. And potential sellers blessed with low-rate mortgages aren’t motivated to sell in a rising rate environment.

As a result, many homeowners have vacated the market, opting to stay in homes carrying low mortgage rates versus selling and buying another home at much higher rates. At the same time, this resultant low inventory of used homes has kept prices from dropping even as home sales in general have declined. Adding to the confusion, first-time homebuyers who can’t afford to participate in today’s market have necessarily curbed purchase activity. Those same potential buyers are now dealing with rising rents and high inflation, which will make it more difficult for them to save down payments necessary to buy homes when the market stabilizes.

Anyone got a crystal ball for sale?