1) The University of Kentucky men's basketball team is favored to win the NCAA tournament with a 38% chance of winning, though predicting outcomes is difficult.
2) Many factors can influence the performance of capital markets, and before events occur, no outcome has more than a single-digit probability; predicting the near-term path is hard.
3) While US stock earnings remain strong, signaling further gains, investors are reminded to maintain a balanced portfolio aligned with their risk tolerance, as market downturns are natural occurrences.
The Triple Threat | Article on Global Resession | Harsh Kumar
Predicting Markets is Difficult
1. Predicting is Hard
Deservedly so, the University of Kentucky men’s basketball is a near-prohibitive favorite to win the NCCA men’s basketball
tournament. Thepowerrank.com calculates the (conditional) probability of any team cutting down the nets after the final
whistle of the final game. Take a look at the nearby chart of individual probabilities. Kentucky, the favorite, has a 38%
chance of winning the national championship. 38% or about one chance in three tries. Each of the other teams still danc-
ing has some probability of success greater than zero. Game day conditions, matchups, illnesses, injuries or distractions can
influence any one of these outcomes. One in three chance, with sixteen teams still in the hunt.
Think about that. In the near term, many multiples
of sixteen highly diverse factors exist that can
influence the path capital markets take and each
has some positive probability of occurring. Any
one factor occurring changes the probability of
all the others occurring next. Before the fact it is
exceedingly rare that any one scenario has more than
a single digit probability of happening. Before the
fact, there are no ‘prohibitive favorites.’ After the
fact, we will convince ourselves the signs were there
and the outcome should have been known. That is
human nature. Before the fact, the outcome was
not known with anything approaching certainty.
Predicting is hard.
We thought of this topic as we read an article
recently. On March 9, the 6th anniversary of the
S&P 500’s current bull market, a writer for USA
Today suggested that “after (the) bull’s long run,
many signs point to (an) impending bear market.”
The article further reported that on October 10,
2002, this same writer said “Where is the bottom, no end in sight?” That day happened to be the very first day of a five year
bull market that saw the S&P 500 double in value. Any one prediction, whether it is a magazine cover or a pronouncement
from a recognized sage, can appear to be foolish or brilliant depending upon its proximity to the outcome. In the near run,
predicting is hard.
Rather than specifically attempt to predict the near
term path of markets, we strive to gauge whether
our recommended asset allocation is the right one
for the capital markets as they exist at any one point
in time. We suggest thinking and investing longer
term but we know that near term events deserve
our attention. For example, we continue to suggest
that US stocks can go higher because stocks follow
earnings and earnings remain on track to grow. But
we know that is only one possibility. The nearby
chart is one ‘sign’ the writer above saw that helped
him think a bear market could be near.
The S&P has marched higher almost uninterrupted since March of 2009. The top line is the path of the market while the
bottom line is the path of a 60% stock/40% bond mix. Over extended periods of time a 60/40 mix can get an investor
to a very similar place to a portfolio of all stocks with much less volatility. The gap between all stocks and 60/40 is pretty
high and many investors lament that they are not fully invested in US stocks. We review the nearby graph and suggest the
opposite. Someday, in the foreseeable future, stocks will back off, maybe by a lot. It is the natural order of things. This is a
good time to make sure your asset allocation and risk tolerance are in alignment. You will be glad that you did.
Michael Weiner, Chief Investment Officer
Unified Trust Company
If you have questions regarding this weeks ‘Under the Hood,’ contact Chief Investment Officer, Mike Weiner.
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