A Word From The Advisor
There Is No Crystal Ball ... and You Don't Need One to Invest Wisely

Imagine you are at the big football game, one that you have been anticipating all season. Your friends have volunteered you to go to the snack bar and get drinks and hot dogs for everybody. While in line, you hear the roar of the crowd, and then the announcer yells “Touchdown!!” Oh, you say to yourself, I missed it! What are the odds of that happening? Then, after waiting in line for what seems like an eternity, you head back to your seat. You’re walking down the tunnel to the field. Again you hear the roar of the crowd, and again you hear “Touchdown!!” This scenario can feel a lot like investing, if you don’t stay invested in a broadly diversified portfolio. You have to stay in your stadium seat to experience the touchdowns, because you don’t know when they are coming. Similarly, you have to stay invested in a diversified portfolio to experience the full potential of returns the market will deliver, because no one can forecast which individual stock or which asset class will be the best, or when. And even though no one can predict the future, you don’t need to in order to have a successful investment experience.

Historically, the track record of market forecasters highlights the fact that experts can be and, many times, are wrong in predicting both the upside and downside. For instance, 90% of economists failed to predict the 1990 recession. The largest investment houses forecast a bull market in Mexican stocks just before the government devalued the peso and sent stock prices reeling. Virtually no one predicted the seven-year decline in interest rates starting in 1991, rewarding those who held fixed income. Senior market analysts incorrectly predicted the coming of a bear market numerous times between 1994 and 1998. Few foresaw the hyperinflation of the late 1970s. When Wall Street finally recognized the inflationary spiral trend, it expected more of the same, promising investors that gold could rise to $2000 an ounce and oil to $100 a barrel. In the last year, at about the same time, most economists wrote off hopes for the sagging US steel industry, which rebounded by the 1990s to become the world’s most efficient and profitable once again. Experts claimed the recession would be much worse than it was in 2002. There was endless debate in the late 1990s and early in 2000 about the endless upward valuation of internet stocks, some feeling correctly that the bubble would soon burst, others predicting the “new paradigm economy” was the new standard.

The majority of market pundits were predicting gloom and doom after the huge collapse in the credit and hedge fund market in August, and yet we stand today near all-time highs across many major markets. The table below highlights an interesting update on the S&P 500 market performance after periods of extreme volatility.

As previously stated, at its recent peak on August 16, 2007, the Volatility Index (VIX) was up 108% from 50 trading days earlier. Since 1990, there have been only six other periods of such intense short-term volatility. Each time, the S&P 500 was higher one, three and six months later. History is not a perfect guide, but the table highlights the market’s tendency to recover, at least in the short term, after volatility spikes.

Movements in the financial markets may not always appear rational and prices may not always be “correct,” but market forces are so competitive that it has yet to be demonstrated that any investor, or group of investors, can consistently profit at the expense of others or consistently outperform the market as a whole. The idea of market efficiency is widely acknowledged by financial professionals and academic researchers alike. Many studies have found that securities prices quickly reflect new information rendering market-beating strategies ineffective.

Some investors believe that they can increase returns, or reduce risk, by moving money into the stock market before it goes up, and out of the market before it goes down. This is commonly known as market timing. Variations of this approach include strategies such as sector rotation and tactical asset allocation. The common theme that ties these strategies together is the attempt to add value by forecasting future market movements, and then moving money to take advantage of this knowledge.

The chart below shows that the vast majority of the return for the S&P 500 Index is captured in a very small number of best-performing trading days. The return is significantly reduced without these best performing days. If an investor were to miss even a few of these days, it significantly reduces the return. This is why it is important to stay invested and stay disciplined.

Traditional active managers strive to beat the market by taking advantage of pricing “mistakes” and attempting to predict the future. Too often, this proves costly and futile. Predictions go awry and managers miss the strong returns that markets provide by holding the wrong stocks at the wrong time. Meanwhile, capital economies thrive—not because markets fail but because they succeed, as is evidenced by the following chart.