Everyone is forecasting that interest rates will fall this year. Last year, everybody made the same forecasts and they were all wrong. While interest rates may fall this year, trying to get that right will mean you miss out on the big picture, which is that we need to remain invested over the long term and not be swayed by short term forecasts to improve our chance of success in investing.
By Samuel Rhee
This article first appeared in The Business Times.
Last year was a surprising year in so many ways. Who could have predicted a 20% rise in stock markets for the broad global stock markets, 26% rise in the S&P 500 Index and the Nasdaq rebounding by 55%. This is against the backdrop of the fastest interest rate hikes by the Fed in over four decades. What was even more surprising was how resilient and strong the US and global economies remained throughout that period.
Most people may not remember this, but as 2022 came to a close and we entered 2023 this time last year, there was a plethora of forecasts in the markets about how interest rates have likely peaked. The forecasters spoke with a common voice that inflation was starting to come down and so interest rates will start to fall and the Fed will likely cut rates during 2023. Like the boy who cried wolf, the constant forecasts of peaking and falling interest rates got pushed back again and again throughout 2023 and we ended the year at peak interest rates and no rate cuts in sight.
Fixed income market returns as a result were negative for the third year running for most of last year, until a year-end rally brought it back into positive territory. Therefore, it is ironic that as we begin 2024, like a rerun of a bad soap opera, we are seeing another round of confident forecasts from the so-called experts parading “new” forecasts of Fed rate cuts and falling interest rates.
Memories are short and there is naturally little mention of the nearly universal failure of the past to be able to correctly predict the direction and magnitude of central bank policy, interest rates, and of course market returns. Little surprise that none of the strategists look back at their past forecasts as another year passes and another forecast is made. It is a strange annual ritual that many people still follow and spend time on.
Anybody would readily admit that human beings are not known for having the ability to predict the future. We don’t even know how long our new year’s resolutions will last. We cannot control our own behaviour let alone predict the behaviour of tens of millions of participants in financial markets and economic activity. In effect, the constant failure throughout last year was the inability to predict the minds of just the twelve voting members of the Federal Reserve.
It’s safe to say that short-term predictions are fairly worthless, and paying attention to forecasts is a wasted effort. As the famed economist John Galbraith put it: “There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know.” But this is not just wisdom from the modern West, the Chinese philosopher Lao Tzu from 6th century BC said, “Those who have knowledge, do not predict. Those who predict, do not have knowledge.”
It is the same reason why even after three decades of experience investing billions of dollars in financial markets, I am still hesitant to answer questions from investors, clients and friends who ask me where I think markets are headed or what they will return this year. With a healthy dose of humility, I am happy to admit and also confidently share that we all have little clue of where the markets will go over the next year and anybody who says they do should be reminded of the quotes above.
What is more important, is not just some pithy quotes from wise but dead men, but the overwhelming weight of evidence from the history of economics and financial markets. This empirical and scientific based approach to investing is the only way for us to overcome our mistaken focus on “getting it right”. Rather, we should focus on what is the highest probability of success or the most likely outcome.
Maybe unlike last year, interest rates will come down and the predictions will come true. But we should always be open to the possibility that it doesn’t. We should also be weary that timing is always something that is even more difficult to predict than the direction of markets. If we had remained invested for the past several years, the effect of compounded annual returns means that at the end of 2023, you would have enjoyed the tailwind of the markets giving positive returns in four of the past five years. Many people don’t realise what they’ve missed.
Therefore, we must also remove the idea that “safe is good” or “cash is king” when it comes to investing our money. If we take anything away from the recent cycle, we should learn that interest rates and inflation always go hand in hand. Even with higher interest rates for our fixed deposits and T bills, we saw inflation running higher than that. This meant that our purchasing power was eroded even at 3-4% or higher interest rates as inflation was even higher than that. If interest rates do fall, then fixed income will indeed give much better returns from higher starting yield and capital gains. However, the only sure way to beat inflation is to invest in equities over the long term. Bonds have held up well but have been much more volatile and correlated to equities in recent years.
The effect of compounding market returns as compared to fixed deposits is clear in the chart. This is true for all your long term investments. In every period of 1 yr, 3 years, 5 years, 10 years or beyond, the stock market and a balanced portfolio have outperformed any fixed deposit or yielding product. That is why long term investors stick to low cost, passive index investing on our platform and the ones that stuck through the volatility in recent years are the ones that have all won out.
This year, let go of what we cannot control - the market direction, the economy, or what will happen to war and pandemics - but on the only thing actually within our control: our behaviour. When you are making those new year’s resolutions about your physical health - to give up smoking and alcohol, or to exercise more and eat less, don’t forget to work on your financial health as well.
New year’s resolutions on investing at the start of the year also see a spike. However, these financial disciplines once set up as regular plans to implement through trusted advisors, whether digital or offline, should be easier to sustain than going to the gym every week. The trick is to keep it simple by setting up some regular savings and investment plans. Developing ongoing good investing habits may be the most important thing we can do this year and the only certain way to better prepare for a future that will always be uncertain.
Samuel Rhee is Co-founder and Chief Investment Officer at Endowus, an independent wealth platform advising over S$6 billion in client assets across public, and private markets. He is formerly the CEO & CIO of Morgan Stanley Investment Management in Asia.
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