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Surprised Again

Adam M. Grossman

“IT’S TOUGH TO MAKE predictions, especially about the future.” That’s one of the more amusing quotes attributed to Yogi Berra, but there’s also a lot of truth to it. When it comes to financial markets, the track record of those making forecasts is not good.

That’s why a rational approach to decision making is to avoid predictions, and instead base choices only on an assessment of where things currently stand. But even that approach can be fraught: Financial trends have a habit of reversing when least expected.

Consider the recent trend in interest rates. Late last year, the Federal Reserve’s policymaking committee indicated its expectation to cut rates several times this year. On average, committee members predicted three rate cuts in 2024 and another four in 2025. Those expectations fueled a stock market rally at the start of this year. Through the end of March, the S&P 500 had gained more than 10%. It had also helped boost gold and other asset classes, while mortgage rates had begun to tick down, providing relief for the housing market.

Everything seemed to be on track—until 11 days ago, when the government issued its monthly inflation report. After several months of improvement, the March report showed inflation ticking up again. Speaking on Tuesday, Fed Chair Jerome Powell said out loud what investors feared: “The recent data have clearly not given us greater confidence [that inflation is moving lower] and instead indicate that it is likely to take longer than expected to achieve that confidence.” Powell added that the Fed is prepared to leave rates unchanged “for as long as needed.”

Not surprisingly, markets dropped in response. So far in April, the S&P 500 has given up 4.5%, and small-cap stocks—which are more vulnerable to rising rates—are down nearly 8%. And because bond prices move inversely to interest rates, bonds have also experienced losses, down 2.5% this month. In short, everything investors thought was true a month ago seems suddenly to have reversed.

Another reversal we’ve seen recently is in the electric vehicle (EV) market. Just a year ago, when Toyota CEO Akio Toyoda chose Koji Sato as his successor, the headlines excitedly focused on Sato’s commitment to EVs. Nikkei Asia’s headline declared, “Toyota’s new chief Koji Sato vows to get serious about EVs.” Bloomberg’s headline read, “Toyota CEO Sees EVs as ‘Missing Piece’ for World’s Top Carmaker.”

Industry analysts agreed. CLSA analyst Christopher Richter argued that Akio Toyoda had been holding Toyota back: “Some of the statements that came out of Toyota when Akio Toyoda was CEO sort of made it sound kind of like hybrids are going to be there forever. No, it’s your standby, it’s your hedge. EVs have to be first.” Earlier this year, when Toyoda, who remains chairman, reiterated his longstanding belief in hybrids and skepticism of EVs, he was pilloried. An auto publication wrote that Toyota’s “hesitation with EVs could set it up for failure.”

For a time, most everyone agreed with this thinking. Despite Toyoda’s skepticism, EV sales were growing much faster than the overall industry, while hybrids looked like they were on their way out. Electric car leader Tesla’s stock doubled last year. But then everything changed. In the first quarter of this year, hybrid sales re-accelerated, growing 43% year-over-year, while EV sales barely grew, inching up just 2.7%. In an effort to boost slowing sales, Tesla was forced to cut prices several times, and last week announced it would be laying off 10% of its workforce. The company’s stock is down 40% this year. In short, everything investors thought they knew about this market a year ago seems to have changed.

Another area that’s seen a near-180-degree shift: the small-cap stocks that capture investors’ imagination. Where are 2021’s hot small-cap stocks today? Relative to their highs three years ago, AMC is down 94%, GameStop is down 91% and Zoom is down 85%. When they were going up, the rally in this group of stocks was reminiscent of the tech-stock rally of the late 1990s. With prices rising seemingly every day, investors were lulled into a sense of security—until suddenly, one day, it stopped.

Perhaps the most notable trend reversals have been in sentiment toward international markets. In the 1980s, Japan’s economy was so dominant that MIT professor Lester Thurow wrote a book titled Head to Head in which he questioned America’s ability to continue to lead the world economically. But when the Plaza Accord was signed in 1985, it triggered a series of events that eventually led to a decades-long economic slump in Japan.

For two decades in a row, Japan’s Nikkei stock market index lost 50% of its value and only recently reclaimed its prior high—after 34 years. As I described in January, a similar story now seems to be playing out in China. Its economy, which many worried was on track to surpass ours, has stumbled in a number of areas. It’s been a remarkable reversal.

Some years ago, the investment consulting firm Callan put together an illustration it dubbed the periodic table of investments. Callan’s objective was to communicate the unpredictability of investment markets. In ranking investments from best to worst each year, Callan’s chart clearly illustrates the sorts of reversals described above. In short, what it shows is that investment performance is rarely consistent. It’s not unusual to see asset classes that have delivered the best performance one year fall to last place the following year. In other words, there’s no consistent pattern to investment performance, and often—just when it looks like there’s a pattern developing—it reverses.

The challenge for investors, though, is that when a trend is underway, it can appear so firmly entrenched that it’s hard to imagine what could stop it, let alone reverse it. But as we’ve seen, that’s precisely when a reversal can occur. What’s the solution? One seemingly rational approach would be to adjust your portfolio when you observe changes in the market. Unfortunately, the data have shown that this approach rarely works, even for professional investors. A study by Morningstar concluded that funds pursuing these sorts of strategies “incinerated” shareholders’ returns.

What’s the alternative? Since reversals are a fact of life for investors—and are completely unpredictable in their timing and impact—the key, I think, is to structure your portfolio so you don’t need to make changes, no matter what the market does. You can do that by building enough diversification and enough margin for error into your portfolio so that a reversal in any one corner of the market can’t materially affect you—and, just as important, won’t cause you to lose any sleep. As I’ve discussed before, try to stay in the center lane.

Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on X @AdamMGrossman and on Threads, and check out his earlier articles.

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