A New Year's Message for Investors

I have been in and around financial markets for around forty years and have been writing about them for about a dozen. In that time, I can’t remember another time when, as the year end approaches, there was such unanimity of opinion about some aspects of the year ahead. Almost everyone sees a year divided into two parts, beginning with stocks under pressure as the Fed continues to tighten, then at some point, maybe after a brief, mild recession, the Fed will relent and the market will bounce back strongly. There are differences about timing and about the potential for an actual recession, but that forecast for a “weak at first, bounce back later” pattern is almost ubiquitous.

That makes sense in so many ways. We know that the Fed is the biggest influence on markets right now, and we believe that must continue throughout next year. They are in the process of executing a policy turnaround that is supposed to be temporary, and has had such a major impact that we cannot imagine anything else being of any importance when the Fed makes its pivot. At some point they will stop hiking rates and if they are behind the curve in terms of timing, will end the year with some rate cuts. That makes it likely that in 2023, stocks will drop at first, then bounce back at some point during the year. Hence, the consensus.

However, one of the most important lessons I have learned over my forty years of trading and related work is that consensus doesn't make a prediction more likely; quite the opposite. Traders call it a “buy the rumor, sell the fact” effect, where everybody establishes a position in anticipation of something, but then when that thing materializes, profit-taking results in a counterintuitive move, even if the consensus turned out to be accurate. Then there is also the danger that things don’t turn out as predicted.

Big market moves, the kind that define a year’s performance, aren’t caused by predictable things. When a general consensus comes into focus, the market prices that in early, simple because of a combination the way they work and human nature. Markets look forward, and always reflect what will be rather than what is, and there is more money to be made if you identify those predictions early. When everyone anticipates a move in the same direction, the pricing will reflect the end of that move before what is predicted to cause it actually happens.

Often, something else comes along before that end state is reached. It may be a foreseeable but largely unidentified liquidity crisis in the banking system, or a global pandemic, or whatever. Or, on the bullish side of things, it may be a decision from China to re-prioritize growth, or a brokered peace deal in a global hotspot. Or it may be that consumers are even more resilient than forecast and as a result, we see boom rather than bust, despite rising interest rates. Or that there is more slack in the labor market than anyone realized. It could be any one of those, or something completely different.

You can see the problem here. If events don’t follow the exact script everyone expects, lots of people are caught off guard and the adjustment to that can be huge. And really, when has a year ever turned out exactly how you thought it would?

As we go into a year where everyone believes they know what is going to happen, be aware that whatever that is, it is the most unlikely of hundreds of scenarios. For investors, that means that you must listen to your own eyes and ears rather than trusting forecasts, no matter how smart they seem or how many times they have made accurate predictions in the past. If I have one New Year’s message for you, it would be “Stay agile, my friend.” Use that as a mantra during the year and you might just avoid big losses.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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