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NATURE ABHORS a vacuum. That’s well known, but when it comes to investing, this poses a particular problem. Why? In the absence of anyone having the ability to predict the future, commentators and prognosticators are happy to step in with stories of their own.
The reality, though, is that no matter how rigorous anyone’s analysis might be, no one can know for sure what the future holds, for the economy, for the stock market or for any individual investment.
Rationally, we know this, but still it’s an uphill battle, because market commentators have at their disposal an endless library of smart-sounding anecdotes and aphorisms to support their views. And they can be convincing.
To see how this works, we can look at some of today’s most frequently debated questions through the lens of these storytellers.
The first question on many investors’ minds: Is the stock market skating on thin ice? For some, this question isn’t difficult to answer. They point to the Cyclically-Adjusted Price-to-Earnings ratio (CAPE). Developed by Robert Shiller, a Nobel laureate, the CAPE ratio is a respected measure of market valuation. Today, it’s at its highest level since the market peak in 2000 and much higher even than it was in 1929, just before the crash.
Compounding these concerns, there’s worry that traditional valuation methods like the CAPE may even be underestimating market risk. Companies in the AI ecosystem are of particular concern because of the ways in which they’re doing business with each other. Nvidia, for example, has announced an investment of as much as $100 billion into OpenAI at the same time that OpenAI is spending billions on Nvidia’s chips. Nvidia has invested in dozens of other AI-related companies, helping further drive demand for its own chips. This calls into question many companies’ earnings. If they’re passing the same dollars around, to some extent, should those dollars be counted as sustainable revenue, or is it a game of financial musical chairs that may come to an end? It’s an open question, but the optics of these deals buttress the argument that the market is out over its skis.
Market bears also like to point to a famous Wall Street anecdote: According to lore, someone once asked J.P. Morgan to share the secret of his success. His reply: “I made all my money selling too early.” Caution, in other words, may be rewarded. Especially in light of the CAPE ratio and other concerns, it sounds like it might be wise advice to take a more conservative tack with one’s investments.
But this is where the anecdotes run headlong into the data. According to a 2023 study titled “Selling Fast and Buying Slow,” a key driver of mutual fund underperformance is that fund managers tend to make errors in timing their sales.
Perhaps J.P. Morgan did benefit by shrewdly selling before market downturns, but according to the data, that’s not the experience of most professional investors.
Who’s right in this debate? My view is that proponents of each argument have a legitimate point. The problem, though, is that what happens in the future can’t be decided on any given set of data. Instead, where things ultimately go will depend on a more complicated interplay among all of the factors out there, from AI to interest rates to elections, geopolitics, and innumerable other factors we may not even be thinking about. For that reason, we shouldn’t put too much stock in definitive-sounding predictions.
A similar debate is swirling around U.S. Treasury bonds. In finance textbooks, U.S. government bonds are referred to as the “riskless asset,” owing to the U.S. economy’s status as the largest and most productive in the world. Because of that, the Treasury has historically been able to borrow as much as it needed each year. Indeed, the government’s debt load topped $40 trillion a few months ago, and its nearly flawless credit rating has allowed Congress to continue financing multi-trillion dollar deficits each year.
It’s for these reasons that some commentators see it as irrational to worry about the U.S. government’s financial position. One recent book titled The Deficit Myth argued that the government could, more or less, print as much money as it wished.
That’s one line of argument. But here too, the stories seem to be in conflict with the data. In the first eight months of this year, the Federal Reserve held rates steady, but despite that, market interest rates rose almost continuously over that period, defying the Fed.
Why would market interest rates rise when the Fed hadn’t made any moves at all? One explanation is that bond investors are growing more concerned about the federal government’s fiscal health. In round numbers, the government now spends about $7.5 trillion per year but is only taking in about $5.5 trillion in revenue, and Congress doesn’t seem to be focusing in any serious way on addressing that gap.
Taken together, these data points suggest that concerns about deficits are definitely not a myth, and that the notion of a “riskless” asset carries with it no guarantees.
As an individual investor, how should you respond to these sorts of debates? This is the simple formula I suggest: First, don’t make changes to your finances in response to any given commentator, since, as we’ve seen here, there often exists an equally articulate, but opposite, point of view on any given question.
At the same time, I wouldn’t entirely tune out the prognosticators. Instead, I would take the time to closely examine your own finances and run stress tests to see how your plan might be affected under each of the various scenarios they predict. Then see if there’s a way to diversify your holdings to protect against those potential outcomes.
Diversification is probably the simplest rule in personal finance but may be the most valuable.
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 check out his earlier articles.
Ignore them all and set up the asset allocation that meets your physical and emotional needs. Have liquid assets to cover whatever number of years you feel comfortable with in case of a downturn, and enjoy the ride. If and when the market crashes, you can ride it out. There is not a soul who has consistently predicted where the market is going, and if all these statistics like CAPE really worked, everyone would be filthy rich.
Aaaaaaamen!