RECENT WEEKS HAVE been challenging for our country. We’ve seen horrific terrorist attacks. The midterm elections suggest the U.S. is deeply divided. While the economy has been doing well, the stock market has started to wobble. October, in fact, was the market’s worst month since 2011.
For all these reasons, folks have been asking me whether they should steer clear of the stock market for a while, until the dust settles. That sounds sensible—until you realize the difficult steps involved:
Step 1: Predict what’s going to happen and when.
Step 2: Predict the impact of the event on the economy and the financial markets.
Step 3: Take action quickly enough to benefit from what you expect to happen. For example, if you thought particular legislation would result in a stock market decline, you would need to sell your investments before other investors did the same thing and drove prices down ahead of you.
Step 4: Decide when to reverse course. Continuing with the above example, even if you believed that particular legislation would cause the market to drop, presumably you wouldn’t want to stay out of the market forever. When should you buy back in? That’s often the hardest step.
Step 5: Determine whether the event in question would have any long-term impact. For instance, the recently enacted corporate-tax cuts gave a boost to stocks, but they’re also driving up the federal debt more quickly than before. Will that have a negative impact down the road? If so, to what degree and when?
It’s exceedingly difficult to get all five steps right. While it was perhaps an outlier, the 2016 election provides a good example of how hard this can be. In the days leading up to the election, nine out of 10 polls predicted Hillary Clinton would prevail. Among those who hypothesized about Donald Trump winning, many predicted a negative economic outcome. For example, Simon Johnson, a well-respected MIT professor, predicted that if Trump were elected, it would “likely cause the stock market to crash and plunge the world into recession.” Goldman Sachs predicted a 25% crash in the Mexican peso. Others had similarly negative expectations.
What’s actually happened? As you know, the economy is doing well. The stock market has been bumpy recently, but it still stands some 30% above where it was on election day 2016. And the Mexican peso is basically unchanged over that same time period. In short, virtually all the prognosticators were wrong.
To be clear, I’m not disparaging those who failed to see what was going to happen. Rather, I’m simply using them to illustrate how hard it is to make such forecasts. In fact, even those in power have a difficult time predicting how things will go.
Cast your mind back to February of this year. President Trump appointed Jerome Powell to lead the Federal Reserve. But barely eight months later, when the Fed hiked interest rates, causing the stock market to dip, Trump bitterly criticized his own appointee. In an interview, the President complained, “I don’t know what their problem is that they are raising interest rates and it’s ridiculous. The Fed is going loco…. I’m not happy about it.”
What’s the solution? Is there any way to protect yourself from the uncertainties of the stock market? As mundane as it sounds, I think the answer is asset allocation. Since the stock market offers no guarantees, the only way to sidestep that uncertainty is to shield sufficient assets outside of the market—by buying bonds and other conservative investments. In addition, be sure that the assets you do invest in the stock market are adequately diversified. Political events can affect some industries more than others. Diversification gives you a better chance of dampening those effects.
Adam M. Grossman’s previous articles include Hole Story, Seeking Zero, Garbage In and All Too Human. Adam is the founder of Mayport Wealth Management, a fixed-fee financial planning firm in Boston. He’s an advocate of evidence-based investing and is on a mission to lower the cost of investment advice for consumers. Follow Adam on Twitter @AdamMGrossman.