No one knows what stocks will do this year, but you can still give yourself a high probability of investment success.
Set informed, well-calibrated expectations. Understand them. Revisit their basic principles when markets turn frenetic.
Here's what we told clients last week...
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The following is borrowed and adapted from a Peltoma Capital Partners client letter.
Capital Market Expectations (CME) are the building blocks for quality investment decision-making.
At investing’s most basic level, there are:
Risk-free assets that come with 100% predictability of future outcomes, and
The riskiest assets that come with 0% predictability of future outcomes
All investments lie on this predictability spectrum, most in between these two points.
Investors should expect higher returns for accepting risk and unpredictability. Over short time horizons, though, risk assets are highly unpredictable and often frustrating.
Having well-calibrated expectations — CME — is a critical part of a successful, long-term investment experience.
No different than other experiences in life.
My 18-month-old daughter loves wailing from 3AM-5AM, pulling my wife’s hair, and occasionally biting us. If I did not have a properly calibrated sense of what is reasonable for a little kid to do, I’d go berserk.
It is not outcomes that drive people mad. It is improper expectations.
For you as an investor, having thoughtful, well-informed CME builds ranges around the age you can actually retire, how much money you can actually spend, and the risks you should actually take (or not take) to get there. These guideposts help with life’s important financial decisions, and temper unrealistic assumptions.
They will also allow your portfolio decisions to be consistently informed by your financial plan, rather than your portfolio becoming a collection of random investments made over the years.
For the past month, many financial institutions have published their own salacious, clickbait forecasts for 2024 stock market performance. I wrote about this pernicious annual activity last year. I'm writing about it again now. It is a useless exercise and deserves none of your attention.
Don’t confuse the dart-throwing of commercialized one-year stock market forecasts with CME.
CME relates not just to (1) forecasting how an asset will perform, but also (2) the volatility of the asset, and its (3) correlation to other assets in your portfolio. As well as external factors like inflation and the implications of current interest rates. The expected shape, quality, and magnitude of these inputs all matter.
It is comprehensive, and should be informed by long-term research and financial science.
Every financial plan requires CME.
We need to know how client money is expected to grow, and how factors like inflation are expected to impact the environment around that portfolio growth. And, critically, we need to understand what the past tells us about how often our portfolio expectations will actually match our portfolio realities – in order to build humble, pragmatic scaffolding around these necessary (and complex) CME inputs.
Otherwise, our reactions to the market just being the market will be like being mad at a little kid for just being a little kid.
As investors – we want to avoid being unrealistically optimistic to the upside, or we may be disappointed in how much money we end up actually having. And similarly avoid being unrealistically pessimistic to the downside, or we may miss chances to have spent more money on fulfilling opportunities.
Many people assume great investing is finance. Sure. But it is also history, design, and psychology.
In the last 15 years, the financial advice industry has evolved from being focused primarily on “asset management” to being focused more comprehensively – now including financial planning, wealth management, tax strategy, etc.
But 2022 and 2023 revealed instances of a pendulum having swung too far away from investment excellence. Countless portfolios that were improperly positioned to address the shock of rising interest rates, but that shock wasn't crazy – just frustrating — and should have been considered as a possible outcome ahead of time.
It is the integration of financial planning mastery and investment mastery that should dominate the current era of financial advice.
Having an expertly-designed investment portfolio is critical to ongoing investment success (go figure). And environments change...
3 years ago:
Could only guarantee yourself 0.09% annualized yield for 3-months.
Could only guarantee yourself 1.08% annualized yield for each of the next 10 years.
You can guarantee yourself 5.48% annualized yield for 3-months.
You can guarantee yourself 3.99% annualized yield for each of the next 10 years.
And so many investors have done nothing with this information. Despite that it's changed everything.
Risk-free rates have skyrocketed. The relationship between time and guaranteed yield has inverted.
I'm not my own therapist, physician, or car mechanic. And the problem isn't that everyone needs each of these professionals in their life at all times, it's that we risk seeing them too late if we only wait until there are major problems.
The longer we wait to address a potential issue, the higher probability that if there is indeed an issue, it will be a bigger issue. There is a reason therapists encourage ongoing work, physicians prefer preventative medicine, and you get oil changes and tune-ups.
Below we share Peltoma’s 2024 CME, with context that we hope is palatable and unintimidating. This is thinking that actually informs client portfolio design and implementation. We are biased to avoiding negative outcomes, and despite that long-term forecasts can be well-informed, they can still turn out to be completely stinking wrong. As such, we dampen long-term forecasts of risk assets when actually modeling out expected outcomes with clients, and encourage all investors to do so.
Why CME conservatism? Why paint someone a slightly-less rosy picture of their likely outcomes?
Because you want buffer for the world to disappoint you. I would rather our financial decisions prioritize a client not going dead broke at age 97, than I would prioritizing attempting to enable four African safaris in retirement instead of just one.
When it comes to these assumptions, there is a major difference between what you are seeing from many financial institutions, and what you'll see from us.
Peltoma is proud of our unwillingness to forecast the unforecastable.
Investors who concern themselves with the short-term returns of high-torque risk assets will inevitably create unrealistic expectations.
Where possible, we give guidance. But our one-year forecasts might seem comical to a financial institution who has incentives to pretend they can forecast the impossible. Peltoma has no such incentive except to potentially attract the wrong type of client, which is not of interest.
History has shown that despite many assets being highly unpredictable over the short-term, there are reasonable levels of predictability over long periods.
Expectations really are everything. If you can mentally prepare to have your portfolio occasionally bite you, pull out your hair, and wail every once a while — you'll avoid making unforced errors during frustrating periods, you'll become an unruffled steward of your wealth, and you'll have engineered yourself a better chance of long-term success.
Happy New Year!
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Footnotes & Disclaimers
"Economic intuition" refers to risky assets having higher expected returns than risk-free rates (in stocks), and the expectation of upwardly sloping yield curves being more common than inverted yield curves (in bonds).
Reference indices for long-term CME: Russell 3000 (US Stocks), MSCI World ex-US (International Developed Markets Stocks), MSCI Emerging Markets (Emerging Markets Stocks), FTSE EPRA Nareit Global REITs (Global Real Estate), ICE 0-3 Month Treasury Index (0-3 Month Treasury Bills), 1 Year Treasury Bill Rate (1-YR Treasury Bills), Bloomberg U.S. 1-5 Year Government/Credit Index (Short-Term Bonds), Bloomberg U.S. Aggregate Index (Intermediate-Term Bonds), Bloomberg U.S. Long Treasury Index (Long Term Treasury Bonds), Bloomberg Global Aggregate Bond Index (hedged to USD) (Global Intermediate Bonds), Consumer Price Index (U.S. Inflation).
Peltoma Capital Partners, LLC is an Investment Adviser offering services in Texas, Montana, and California, as well as in other jurisdictions where exempt from registration. All views, expressions, and opinions included in this communication are subject to change.