If there was ever a year that we were reminded of the difficulty of making stock market predictions, it was 2020. Yet, many clients continue to search for "expert" market outlooks in hopes of positioning their portfolio to outperform. A well-known financial publication surveyed 10 Wall Street analysts1 at the beginning of 2020, to make a few predictions of the year ahead:
- The general consensus was that the S&P 500 would rise 4.1% in 2020. Even the panel’s most bullish predictor undershot the final S&P 500 gain for the year.
- These same strategists predicted that the 10-Year Treasury would end the year yielding 1.89%, more than double the 0.919% yield on December 31st.2
- When reviewing different sectors, 8/10 of the panel were overweight financials heading into 2020. The financial sector was one of the four sectors that experienced losses in 2020.
Of course, no one would have predicted that we were about to suffer one of the worst global health crises in our recent history, forcing unprecedented closures of businesses, schools, and changes to life as we know it. Once the pandemic settled in and threw a wrench in many of these predictions, the analysts adjusted their forecasts. Many of them predicted that the S&P 500 would not rise at all in 2020. In fact, they predicted an 11% downturn in the market for 2020. As of December 31st, 2020, the market returned 18.4% for the year. In such a crazy year filled with huge stock market swings, it’s tough to fault anyone for failing to make an accurate prediction. But, 2020 was not an anomaly as far as market predictions go. In fact, year in and year out, economists across the industry give their outlook for the upcoming year and they often turn out to be as accurate as a weatherman calling for rain in the desert.
WHAT DOES ALL OF THIS MEAN FOR 2021?
It means that success in the market doesn’t require making accurate predictions. Success in the markets requires the ability to stay in the game and to make small, purposeful tweaks to portfolios during periods of volatile market instability.
It’s worth a mention here to discuss the most recent trading phenomenon, GameStop, and other popular “meme” stocks such as AMC, Blackberry, and Bed Bath & Beyond. The story is pretty incredible to follow. Last week it appeared as though GameStop stock could not be stopped, despite the fact that the company has seen five new CEOs since 2017, was on the brink of bankruptcy earlier this year when its stock hit a low of $2.57 in April 2020 and has seen profits steadily decline over recent years. GameStop shares closed Friday (1/22) at $65.01 and proceeded to jump to $144.47 by mid-morning Monday (1/25). It was the single most traded name in the U.S. stock market on Tuesday (1/26) as it continued to soar into after-hours, opening at roughly $308.00 on Wednesday (1/27), this all on the heels of retail traders and an army of individuals from Reddit’s “WallStreetBets” forum clash with short-sellers.3
When an investor(in this case the hedge fund, Melvin Capital) goes short a stock, they are making a bet that the stock will decline in price. They borrow shares of the stock and immediately sell them, hoping that they can buy later at a lower price, return the borrowed shares to the original lender, and pocket the difference. A short squeeze occurs when a stock sharply jumps higher (GameStop), forcing traders who had bet that its price would fall, to buy it in order to forestall even greater losses. These investors who were short, are essentially being “squeezed” out of their short position as they cut their losses.4 Short-seller net-of-financing mark-to-market losses in GameStop have reached an incredible $6 billion in 2021 as short interest exceeded 100% of the shares outstanding at one point.5
Because there is no limit on how high a stock can go, the market risk you face as a short seller is potentially unlimited. A group of traders on Reddit effectively orchestrated one of the biggest short squeezes of all-time, and in the process forced a prominent hedge fund to seek close to $3 billion in outside capital to shore up its finances.6 Put simply, a message board took down a hedge fund that was short GameStop. Investors should be aware of the risk associated with shorting stocks before entering positions.
When we hear stories like this, as investors we tend to think that we are fighting a losing battle. There is a lot of misinformation out there, that hedge funds will get bailed out (they aren’t, and in this case made an unfortunate bet using their own investor's money). On the flip side, there are tons of stories about these Redditt users becoming millionaires off of these trades. It makes us stop and think if we should hop on the bandwagon, and start trading according to the message boards. Markets can be crazy and feel really unfair in the short-run. But, as a reminder, there are no shortcuts to building long-term wealth.
Recently, Vanguard was able to attempt to pinpoint the value add for an advisor-client relationship.7 There are many factors that make this an incredibly nuanced and difficult calculation. For example, for some investors who may not have time, willingness, or ability to confidently handle their financial matters, working with an advisor helps to bring peace of mind. The value of an advisor in this context is almost impossible to quantify. In other cases, investors may simply want to spend their time doing something else, similar to the reasoning of why we hire landscapers, house cleaners, and painters. We may be capable of handling a paintbrush to update a few rooms, but our time is valuable, and we are willing to pay for such an emotional benefit. Plus, the professional painter might even do a better job.
As it turns out, guidance and discipline, and necessary rebalancing, combined with overall planning holistic advice, working with an advisor adds about 3% in net returns. Trying to pinpoint a value on value is always a difficult proposition. Each individual investor is unique and has their own set of goals and challenges. Just as in the past, we don’t know what 2021 will bring. Hopefully, an end to the pandemic and a return to life as “usual.” We don’t know how markets will react, or which new trading frenzy will eventually be all anyone talks about, but we can stick to our investing discipline and take advantage of new opportunities.
1 Nicholas Jasinski, “Barrons 2020 Outlook: Stocks are Headed Higher. Here’s Which Sectors Will Benefit the Most”, Barron’s, December 16, 2019
3 Source: https://www.marketwatch.com/investing/stock/gme