Much of the research and analysis provided by the financial industry has as its guiding principle to ascertain which investments will do well and which presumably won't. Although not part of this industry, our Newsletter frequently takes a stab at doing this as well, but solely for the benefit of our readers since we do not sell anything. However, there appears to be a deep seating cynacism among many or even most people that anyone can really predict the future course of stock or bond prices. As a result, much of what any analyst or newsletter writer says is taken with a grain of salt.
There appear to be two main schools of thought on whether any sustained accuracy is possible. The first says that beyond luck, no one can really predict the future direction of any particular investment. The second is often subscribed to by the majority of active investors who often believe they can "intuit" which investments are going to do best without taking sufficient time to study those economic factors that might truly matter. But like most debates, the truth probably lies somewhere in between these two extremes.
An extended examination of literally hundreds of pieces of economic data has lead me to the following perhaps surprising conclusion: There is indeed a positive relationship between key ongoing economic data and the eventual performance of given categories of investments, BUT that relationship is small rather than large, and often takes many months if not up to a year or more to become apparent.
In other words, such factors as inflation and interest rates, just to name a few, do eventually affect mutual fund stock and bond prices, although frequently only when watched over an extended period of time. As a good example, anyone who invests in interest-sensitive stocks or bonds during a period of sustained rising interest rates may appear to be "getting away with it" for a while, but will probably wind up "pay the price" eventually.
On the other hand, if you are truly a long-term investor, such things as rising rates or even recessions, may not be worth getting overly concerned about since they are, after all, only transitory events that come and eventually go. That's why long-term data show that even if you happen to be unlucky enough to invest at what turns out to be an inopportune time, for those who hold their investments year after year, the outcome can still be quite favorable.
But as contrasted to the above performance-enhancing results based on real economic data, investors are often driven to act based on the prevailing psychological climate. For example, investors seem to frequently be propelled to buy certain funds primarily because of their previous outstanding performance numbers regardless of the evidence of mounting risks. Conversely, investors can stampede to indiscriminantly sell when they see that the market as a whole has dropped considerably over a short period of time.
In such instances as these, it appears that more often then not, the overriding emotion turns out in retrospect to have been the wrong direction to have gone in. People who sell into a crash usually wind up regretting it; people who buy when prices are at a fever pitch may wind up being burned as well unless they are prepared for the possibility of a long period of underperformance. The relationship, then, between investment decisions that are psychologically driven and eventual investment results tend to be by and large negative.
However, for most investors, investment decisions are made through a combination of economic data AND psychological data. As a result, the above positive and negative influences to investment success may serve to cancel each other out. Perhaps that's why many people get the idea that there is no consistent relationship between the effort you expend attempting to set up and occasionally modify your portfolio and your ultimate degree of success. But by sticking to the performance-enhancing knowledge afforded by important economic data, and avoiding the performance-detracting influence of following what the crowd is doing (or has already done), you will start to see your returns grow better and better as time goes on.
We believe, and our long-term track record (over 16 years) seems to support, that a careful analysis of economic data can lead you to improved investment performance. And if you don't have the time or interest to study the appropriate economic data, you can still get nearly the same amount of benefit by regularly reading a publication such as ours that does much of the work for you.
Tom Madell, Ph.D.
