Future Investment Returns are Always Uncertain

A little more than three years ago, I wrote There Are No Facts About the Future. It feels like I could change a few recent facts and repost that note. I’ll provide some original work here, but that one’s worth a read if you’re having trouble falling asleep.

My guilty pleasure of reading annual forecast reports by several Wall Street banks and investment managers drew me back to that. I know they have a spotty track record and are not actionable. However, as I noted in "Facts," we have the predisposition to make sense of the future by looking for patterns, and the forecasts are an attempt at pattern-seeking to alleviate an uncertain future.

For instance, we just completed the second banner year for stocks – the S&P 500 rose 25% (including dividends) in 2023 and 2024. At the beginning of 2024, the average Wall Street expectation for 2024 was a 2% return. The chart below was originally shared last year to illustrate how drastically different actual returns are from forecasts. It has now been updated through November 2024. No surprise – they were once again way off the mark.

At the beginning of 2025, the average Wall Street bank strategist expects an 11% return this year. Based on the track record of the chart above and when combined with an analysis by Bespoke Investments that showed a 0% correlation between Wall Street strategists’ forecasts and actual returns going back to 2000, we should put little emphasis on these forecasts.

Unfortunately, forecasts can also be taken from benign information to potentially confusing or harmful recommendations to allocate more or less to stocks or bonds. For their 2025 outlooks, one prominent investment manager recommends overweighting bonds, while another recommends overweighting stocks this year.

When we hear about any widely discussed risks to financial markets that may either support or contradict a forecast, it can be helpful to remember that neither a housing-induced liquidity crisis that led to the Great Financial Crisis nor a global pandemic was cited by the Economist or Barrons as market risks in 2007 or 2019. Also, the release of ChatGPT, which ushered in the AI era at the end of 2022, was unexpected by markets to help move them in the other direction.

Events—whether perceived as risks or opportunities—that are widely discussed and expected by markets tend not to have the most significant impact on them. Truly surprising events tend to have the greatest impact on them. And, by definition, a surprise can't be known in advance.

In "Facts," there were three remedies cited by the HBR article from that note to address our biological aversion to the uncertainty that can be applied to help with our investment success.

1. Set expectations with realistic optimism
2. Lift to bigger-picture thinking
3. Embrace candor

Set expectations with realistic optimism

After two consecutive 25% return years from the S&P 500, should we expect a three-peat? Probably not. Sorry. But that also doesn't necessarily mean we're in for a down year or a noticeable decline during the year – but it could happen. Since World War 2, there have only been two times when the S&P has posted back-to-back 25% or greater annual returns – the early '70s and the late '90s—hardly a robust sample set from which to draw patterns. One was followed by a 7% year and the other a 21% year.

The image below, first posted in "Facts," might be even more relevant today. In 2024, the S&P 500 experienced 57 all-time highs, and we're nearing two and a half years following the 25% decline in 2022. This tells us whether we start the clock at an all-time high or amid a decline, and all we need is a little patience with markets.

In "Facts," I followed this image with the following text:

The five-year result following either a market high or a 20% decline is basically a tie. We can set a realistically optimistic expectation that, regardless of prevailing conditions, we're likely to be appropriately compensated for the risk of our investments. Notably, the article mentions that unrealistic optimism consistently predicts failure. This may manifest in expecting speculative, undiversified investments to keep rising or even diversified investments to rise in a straight line.

One could also reasonably conclude that unrealistic pessimism may predict failure when equity markets have a history of increasing in approximately three out of four years. This leads me to our next remedy.

Lift to bigger-picture thinking

The most significant benefit we all have when it comes to investing is time. Despite the short-term focus of annual market forecasts, we have the immense advantage of investing for much longer than one year, and that is where the real power of compounding happens. Unfortunately, it's all too easy to get caught up in the day-to-day events and never-ending news flow. In "Facts," I began this section with the following paragraph:

The study in the article notes that when we think about a larger meaning or purpose, we’re “more inspired, motivated, and feel greater boosts to self-esteem and well-being.” However, we’re better at solving concrete problems and anticipating obstacles when focused on the details. Ideally, we could shift between the two levels optimally based on the situation at hand. Unfortunately, because we're human, we naturally shift down a level when faced with difficulty, often at a time when big-picture thinking would be most advantageous to our investment success.

I particularly like the last line of that paragraph. It conjures up the phrase most often attributed to the 7th-century Greek soldier Archilochus, who said that we don't rise to the occasion; we fall to our training. I've often said that we can't predict what markets will do, but we can prepare for whatever market environment we're likely to encounter.

Bigger picture thinking means remembering that your investment plans are designed with the expectation that markets will go in cycles. Most events that throw markets off course should be greeted with a "this too shall pass" attitude, knowing that the power of long-term compounding is greater than any short-term event.

Even if we set realistic expectations and focus on the bigger picture, we still need to be candid with ourselves and those around us. While the markets' compounding power is great, their ability to humble us is nearly as great.

Embrace candor

Have you heard anyone on cable financial, business, or political news say, "I don't know"? Neither have I. In "Facts," I began this section with the following:

The third and final solution offered by this article concerns honest communication. While it may lead to learning things that aren't entirely what we want a particular outcome to be, a study cited in the article notes that a lack of transparency and empathy can cause greater damage. We can tell when information is being withheld, leading to heightened uncertainty.

You may have read in these pieces in the past that this is a prediction-free zone. It continues to be. And while there are no facts about the future, we can draw probabilistic comparisons from the past.

Many of you have asked my colleagues and me what the incoming administration may mean for markets and the economy. The only right answer is some variation of "I don't know." However, we can make some probabilistic comparisons to the past and use the power of compounding.

Since the Hoover administration, every administration has experienced a bull market and a bear market during their term or terms, and all but one has presided over a recession.

In the image below, the left panel suggests that Team Blue may have a historical advantage in the markets. The right panel, however, confirms Charlie Munger's rule for investing that compounding should never be unnecessarily interrupted. Regardless of the shifting political winds, sticking to your investment plan is the only winning strategy.

When taken together, setting expectations with realistic optimism, lifting to bigger picture thinking, and embracing candor can help alleviate uncertainty about the future of markets and avoid the theatrical nature of annual forecasts.

What’s going on with interest rates?

Before I wrap up, I want to address something that has received much attention over the past few months. To many, it may seem counterintuitive that the Fed began cutting its benchmark rate in late September, but every other interest rate has risen since then.

In particular, the 10-year Treasury has increased substantially since the first rate cut. After bottoming right before the Fed's first rate cut, it has gone mostly straight up, except for a brief dip in December. The second image below shows this is the opposite of what typically happens in early rate-cutting cycles.

Figure 8: An unexpected path for interest rates in recent months. Many investors may have pivoted to longer-term bonds, assuming that falling rates would lead to capital appreciation from their bonds.

This result has not provided the hoped-for reprieve in mortgage rates for potential home buyers as mortgage rates are typically benchmarked to the 10-year Treasury.

There are many explanations for this behavior, but the main one seems to be that this is a Fed rate-cutting cycle in an otherwise strong economy with a robust employment market and inflation continuing to sit just above the Fed's target.

Additionally, market expectations have shifted so that due to the continued economic strength, the Fed's rate-cutting will not lower the Fed Funds Rate as low as initially expected. While the Fed sets only one rate, the market sets the rest of the rates, and for now, the market sees a stronger economy that likely won't require rates to be cut as low as initially expected.

I hope 2025 is off to a great start for everyone!

Thanks for reading.