Morgan Housel wrote a great piece on why it’s so hard to predict outcomes. Really, it’s about feelings.
How investors feel about stocks five years from now will have a big impact on performance between now and then. If you could semi-accurately predict broader shifts in market mood, you’d do fairly well for yourself. Except, predicting how people will feel in the future is just as hard as predicting everything else about the future.
The second – predicting future expectations – is even harder. To know where stock prices will be in five years, I have to know what mood people will be in five years from now. Which is as ambitious as it sounds. Ask yourself what kind of mood you yourself will be in in April 2021, and you’ll shake your head in laughter. Ask what kind of mood seven billion strangers will be in in April 2021 – that mood, of course, will determine stock prices in five years — and it’s hard to keep a straight face. This is where the disconnect between performance and outcomes occurs: Accurately predicting five years of economic growth might not do much for the stock market if, five years from now, people are worried about the future five years from then.
The mood of the market waxes and wanes like the tide.
Attitudes change.
Investors like something else more, or become more or less fearful, greedy, or whatever. As much as people say “the fundamentals matter” or “prices eventually move toward value”, the move happens because people are willing to pay for it or not.
It’s not as though investors wake up one morning willing to pay fair value either. Rather, the shift in mood begins gradually then accelerates. As is most often the case, prices overshoot value. And it misses it completely in both directions.
Joel Greenblatt gives one explanation in The Little Book that Beats the Market:
So maybe people simply justify high prices by making high estimates for future earnings when they are happy and justify low prices by making low estimates when they are sad.
Housel offers a similar take:
Companies earn a profit. When investors are in a good mood, they pay up for that profit. When they are in a bad mood, they pay less. Future stock returns will equal profit growth, plus or minus the change in investor attitudes.
No surprise. People will pay more for things they like than for things they hate. And the stock market measures this daily. And because it’s measured daily – reported on by the second – the mood of the market gets amplified.
Just look at the 52-week highs and lows for any given stock. The difference between the two can range widely. Yet, we’re to believe that somehow the value of the business changed that much too. For a few companies, yes. But not for all of them.
The good news is that attitudes shift all the time. History shows just how fickle investors can be. We consistently change our minds.
Last Call
- Everyone Worries Too Much About ‘Black Swans’ – N. Smith
- Apocalypse Soon – S. Godin
- Second-Level Thinking: What Smart People Use to Outperform – Farnam Street
- Buy the Best, Perform the Worst – J. Rekenthaler
- Alpha or Assets – Investor Field Guide
- Steve Case Is Bullish on Tech’s “Third Wave” – BackChannel
- The Biggest U.S. Tax Breaks – Pew Research
- Timeline: A Brief History of Oil Prices – DoE
- Delusions of Objectivity – T. Harford
- The Past, Present, and Future of Value Investing (video) – B. Greenwald
