PETER DOLEZAL: Predicting 2016 financial markets

Unpredictable world events will inevitably occur to throw off even the most-meticulously-founded predictions.

Each year-end, the Globe & Mail canvasses economic forecasters for their predictions of market performance for the coming year. Rarely do they win a prize for accuracy, either individually or collectively; 2015 proved no exception.

A year ago, forecasters predicted oil’s return to a range of $65 to $70 a barrel; it ended 2015 at roughly half that value. GDP was to average 2.4 to 2.5%; at year-end, it will likely have settled near 1.25%. Interest rates were to have risen by at least 0.5%; they actually declined by that amount.  The TSX Composite Index was predicted to increase by a range of 6.8% to 11%; it finished the year down 11.1%.

We can empathize with the forecasters, rationalizing that these significant misses  stemmed largely from one factor — oil prices. Had oil in fact reached $65, the other key performance indicators would likely have delivered closer to forecast.

The lesson in this is that a major, or series of smaller, unpredictable world events will inevitably occur to throw off even the most-meticulously-founded predictions.

If we absorb the fact that even our nation’s “experts” almost always fail to make accurate annual predictions, how realistic are we, as investors, in thinking that our personal investment strategies can outperform what the market will actually deliver?

Yet, many of us continue to try.

Not only individual investors, but also fund managers persist in selecting individual stocks, bonds and mutual funds in the belief that their choices will outperform market indexes. Rarely does success follow — for the same reason that even the more “knowledgeable” forecasters fail.

No one can consistently predict broader market performance, let alone individual elements such as that of specific stocks or bonds. Sad to say, the investor rarely even realizes the degree by which his/her investment performance misses index averages.

We tend to delude ourselves — if our portfolio value increases in any year, we congratulate ourselves on the wisdom of our investment strategy. Rarely do we stop to carefully compare the various elements of our portfolio’s performance to that of comparable market indexes. If, on the other hand, our portfolio value declines, we rationalize that it was beyond our control; we were caught in a general market decline. We fail to compare the degree of our portfolio’s decline to that of relevant market indexes, to determine whether we did better or worse. We should.

It bears repeating — we have compelling proof of market underperformance; particularly so with mutual funds, even though overseen by extremely smart managers.  Due primarily to the Canadian average 2.35% Management Expense ratio (MER), only a minority of mutual funds outperform their comparable market indexes in any year — as repeatedly confirmed by the annual, independent SPIVA report.

If, in a given year for example, the comparable market index were to rise by a respectable 4.7%, the average mutual fund would have to beat that performance by 50% before the investor would break even with the index performance.  It happens; in any given year 20 to 30% of mutual funds may in fact beat their comparable index, either through skill or luck — probably a combination of both. The majority however, fail to do so. Because the MER fee is charged regardless of results, it is the investor who pays the price of under-performance.

The remedy does not vary. It is naïve to think that our own, or a fund manager’s, investment strategies will consistently outperform an unpredictable market.

So why try?

The alternative?

We can opt to simply track a market index or sub-index, at very low cost, mirroring its performance almost exactly — whether up or down in a given year.  We can then sit back, taking comfort in the proven fact that if we stay invested over the long term, particularly in dividend-paying sectors, our portfolio values are very likely to grow in value.

What about 2016?

Do we dare make reliable predictions? Absolutely not. But here are some historical facts which may provide guidance.

Rarely does a broad market index in North America deliver two sequential years of negative performance. And, the steeper the decline in a market or market sector (oil?) the more quickly, and aggressively, it tends to recover, often because it has been oversold on the downslide.

In examining the dozen “Bear” markets of the last 60 years, we see dramatic proof of this tendency. In a nine-month period in 2008/09 for example, we saw the TSX decline by some 40%, only to bounce back by almost 50% in the following year.

Will this be true for oil, other commodities, and the TSX in 2016?

No one knows for sure; we can only hope that history repeats.

I remain content with my low-cost, dividend-paying, index-sector choices, knowing I’m on the safest proven path — tracking index performance over the long term.

 

A retired corporate executive, enjoying post-retirement as an independent Financial Consultant (www.dolezalconsultants.ca), Peter Dolezal is the author of three books, including his most recent, The Smart Canadian Wealth-Builder.

 

Contact Panorama Rec Centre to register for Peter’s Elder College Spring session — Financial & Investment Planning for Retirees & Near-Retirees (Wednesdays, March 23 to April 20).