Can a crystal ball make you rich?

Can a crystal ball make you rich? 

By James Parkyn - PWL Capital - Montreal

Markets are tough to predict even with advance information 

Imagine owning a crystal ball that lets you see tomorrow’s news in advance. You could cash in and get rich! 

Not so fast, says statistician and financial writer Nassim Nicholas Taleb, author of best-seller The Black Swan: The Impact of the Highly Improbable. “If you give an investor the next day’s news 24 hours in advance, he would go bust in less than a year,” he warns. 

Taleb’s assertion now has backing from a study by Victor Haghani and James White of financial management firm Elm Wealth. 

WSJ trading experiment 

They did an experiment with 118 U.S. university graduate students—90% in finance or MBA programs—to test Taleb’s claim. 

The students each got $50 and the front page of the Wall Street Journal (with market price data blacked out) published on 15 random days from 2008 to 2022. They then got the chance to bet on how the S&P 500 Index and 30-year U.S. Treasury bonds would do the next day.  

They could go either long (that is, bet the market would go up) or short (bet that it would go down). They were also allowed to use leverage of up to 50 times—meaning they could borrow to increase the size of their trades to potentially make (or lose) more money. 

Students broke even 

The study’s “Crystal Ball Trading Challenge” (which you can try yourself here) showed how hard it is to predict the markets—even if you have advance knowledge. The students grew their $50 to $51.62, meaning an average return of only 3.2%. The result was statistically indistinguishable from breaking even, the paper noted. 

Just under half of the students (45%) lost money, while 16% went bust. The players made winning trades only 51.5% of the time. 

While students bet on the direction of bonds correctly 56.2% of the time, they were right about the S&P 500 in just 48.2% of the trades. Moreover, they compounded their errors by using more leverage in their stock’s bets (where they were wrong more often) than in bonds trades. 

Ordinary participants lost 30% 

As middling as these results were, however, the students fared much better than the roughly 1,500 people who played the game on the study authors’ website. These participants’ median result was a 30% loss. Only 40% made a profit, and 36% lost everything. 

The study, titled “When a Crystal Ball Isn’t Enough to Make You Rich,” also included results from a select group of five very seasoned and successful traders from top organizations. They all made a profit, with a median gain of 60%.  

But even they were often wrong. They placed losing bets 37% of the time. The study found that they did better than the students mostly because of how they strategically used position sizes to place bigger bets when they had more confidence. 

“Taleb is right”  

These seasoned professionals’ superior results suggested that “there are teachable skills involved in successful discretionary investing,” the study said. 

But for the vast majority of people, “by and large we think Taleb is right,” the authors concluded. 

“It’s very humbling,” Haghani was quoted saying about the results. “Even if you have the news in advance, it’s still really hard to do asset allocation or whatever with a high chance of being right, let alone not knowing what’s going to happen.” 

Timing the market is a gamble 

The study is just another good example of how hard it is to guess what markets will do. Even advance information appears to be unhelpful for most people, and it may actually be ruinous for some.  

And in the real world where we don’t have the next day’s news, timing the market is even more of a gamble. 

Investing shouldn’t be about gambling. Data shows you’re better off with a diversified portfolio and long-term investment plan that you stick to with discipline. This can help you tune out the headlines and better capture the returns that the markets have to offer. 

We can leave the crystal balls for the carnival. 

Read more commentary and insights on personal finance and investing in our past blog posts, eBooks and podcast on the website of PWL Capital’s Parkyn-Doyon La Rochelle team and on our Capital Topics website.   

TAKE ADVANTAGE OF THE EXPERTISE OF JAMES PARKYN, Portfolio Manager at PWL Capital Montreal to determine the best solution for you.

Navigating the Market Turmoil

Navigating the Market Turmoil 

By James Parkyn - PWL Capital - Montreal

Stick to your plan and adjust allocations as needed 

Market dips aren’t usually much fun for investors. But they’re often a good opportunity to take stock.  

It’s important to remind ourselves that occasional pullbacks aren’t just inevitable; they can be healthy, even in a strong bull market. Market turmoil can also be a good time to check if we need to rebalance our portfolio and review allocation targets and risk tolerance. 

In the first of our two-part mid-year market review, we looked at how stock markets soared in the first half of 2024. Canada’s S&P/TSX Composite Index was up by 6.05% in the first six months of the year. Internationally, almost all the main indexes we follow made new all-time highs. 

U.S. equities did especially well. The S&P 500 hit a remarkable 31 new all-time highs by mid-year, with tech stocks helping to drive the index to its 13th best yearly start since 1950. 

Pullback was inevitable  

Given the long stretch of almost uninterrupted gains, a pullback at some point was inevitable. Indeed, the TSX kicked off August with a sharp tumble, losing about 5% from its high to the low three days later. 

South of the border, the S&P 500 lost approximately 8% in those same three days before mounting a recovery. The tech-heavy NASDAQ-100 Index has done worse in a decline that started in mid-July, dropping about 15% by August 5. 

Japan has fared especially badly, with its Nikkei 225 Index plummeting about 25% from its mid-July peak to the August 5 low.  

Turmoil explanations vary 

Why did markets go berserk? Some pundits blamed disappointing U.S. job numbers, while others pointed to a sudden rise in the Japanese yen and a bursting tech bubble. “The simplest explanation,” wrote columnist Jason Zweig in The Wall Street Journal, is that “markets went haywire early this week because markets consist of people, and crazy behavior is contagious.” 

The fact is occasional pullbacks aren’t just inescapable in healthy bull markets; they’re common and may even be beneficial. They can work like a release valve when stocks get too steamy, and they provide a good basis for a new rally. 

“Uncertainty is underrated” 

Corrections are also part of the risk that investors take on in order to make a return, as Dimensional Fund Advisors chair David Booth explained in an insightful recent commentary in Fortune. 

“Uncertainty is underrated. Without it, there would be no surprises, no joy in watching sports, and no 10% average annualized return on the stock market over the past century. All investments involve risk—there is no guarantee of success. Investors can be rewarded for taking on the risk of not knowing exactly how things will play out.” 

Booth said the job of investors is to manage their risk: “That means ensuring our portfolios are diversified across regions and asset classes.” 

Good time to rebalance  

At PWL, we couldn’t agree more. Our approach is to manage risk with an evidence-based approach of passive long-term investing in a diversified portfolio. As asset values fluctuate, we also regularly rebalance to maintain allocation targets. 

For readers who aren’t clients, we suggest regularly reviewing your portfolio to see if it’s still in line with your targets. This is especially important after a prolonged rally such as the one we’ve seen since September 2022. 

A rally can cause the stock portion of your portfolio to be significantly greater than it should be based on your investment plan and risk tolerance. In that case, you may need to rebalance your portfolio to bring it back in line with your targets. 

Reflect on targets and risk tolerance 

The recent turbulence is also a good opportunity to reflect on your allocation targets and risk tolerance. Be sure they’re still aligned with your needs and expectations.  

If you feel you can stay the course during a correction, there may be no reason to make changes.  

A skilled financial advisor can help you craft an investment plan to ensure sufficient funds to live on and protect your legacy. 

Follow your investment plan with discipline 

The most important lesson of all is to follow your investment plan with discipline and shut out the market noise. That’s especially important when noise levels rise.  

As money manager Shelby M. C. Davis, founder of Davis Selected Advisers, has said, “History provides a crucial insight regarding market crises: they are inevitable, painful and ultimately surmountable.” 

Indeed, since the early August pullback in stocks, the main Canadian and U.S. indexes have recovered a good part of their losses. No one can know if the turmoil will continue, but we can get some peace of mind knowing that pullbacks eventually end. And in the meanwhile, following an investment plan with discipline can help you stay the course. 

Read more commentary and insights on personal finance and investing in our past blog posts, eBooks and podcast on the website of PWL Capital’s Parkyn-Doyon La Rochelle team and on our Capital Topics website.  

TAKE ADVANTAGE OF THE EXPERTISE OF JAMES PARKYN, Portfolio Manager at PWL Capital Montreal to determine the best solution for you.

Embracing Market Highs

Embracing Market Highs

By James Parkyn - PWL Capital - Montreal

Stocks are soaring. Should we worry? Research shows staying invested is the best approach

Equity markets have been on a tear for months and are regularly making new highs. The S&P 500 was up 15% year-to-date as of late June, with the index reaching new record highs 33 times this year so far. The Nasdaq 100 index is doing even better—up 18.1% in 2024.

Most investors in stocks are rightfully pleased. But this is also a time when questions arise about how to respond to sky-high equity prices. Is it best to wait for a correction to add to investments? Perhaps it’s even a time to take profits and lighten up on holdings?

At PWL, we see rising stocks as a sign of a strong economy and something to embrace. Market highs are a normal and healthy phenomenon that investors should welcome. Our view is that it’s time in the market that counts, not timing the market.

As Warren Buffett once observed, “The only value of stock forecasters is to make fortune tellers look good.”

New market highs are common 

It turns out there’s good data to support this view of market highs. The broad U.S. equity market has made 1,250 new highs since 1950, or over 16 per year, according to a recent report from RBC Global Asset Management.

Interestingly, RBC found that investing in the S&P 500 only at all-time highs would have led to a return “close to the average return of the index for one, two- and three-year periods.” In other words, there was little difference between investing at highs and investing at any other time.

You might think a market high is the very worst time to invest. Not necessarily. In fact, since 1950, the average five-year return for investing only at all-time highs was 10.3%. That compares to 11.3% for investing on all other dates. “New market highs are not as meaningful as some people may think,” RBC said.

A retreat isn’t inevitable

Research from Dimensional Fund Advisors came to a similar conclusion. Its report, titled “Why a Stock Peak Isn’t a Cliff,” found that average annualized compound returns after a new monthly closing high were 13.7% after one year, according to data from 1926 to 2022. This was actually higher than the 12.4% return after months that ended at any level.

Five years later, the comparable returns were 10.2% after closing-high months versus 10.3% for all other months.

“History shows that reaching a new high doesn’t mean the market will then retreat,” Dimensional concluded. “In fact, stocks are priced to deliver a positive expected return for investors every day, so reaching record highs with some regularity is exactly the outcome one would expect.”

Correction fears 

But isn’t there a higher risk of correction after an all-time high? This is a valid question. Legendary investor Peter Lynch addressed it nicely with this comment in 1995: “Far more money has been lost by investors preparing for corrections or trying to anticipate corrections than has been lost in corrections themselves.”

RBC also evaluated this question in its report. It looked at how often the S&P 500 has finished down by over 10% after an all-time high since 1950.

One year out, the market had such a correction 9% of the time. Three years on, the market was down 10% or more only 2% of the time. And five years out, the index has never been down by more than 10%.

Protect yourself with a good plan

Corrections are inevitable; markets are down one in four years on average. But there’s no way to predict when a correction will happen, and the evidence shows they don’t happen after every market high.

What we can do is prepare. At PWL, we do this with our evidence-based approach of passive long-term investing in a diversified portolio. As asset values fluctuate, we regularly rebalance to maintain allocation targets.

It’s a good idea to regularly review and update your long-term investment strategy and asset allocation with an advisor, especially if your goals or risk tolerance changes. But what’s most important is to follow your plan with discipline—no matter what the market does day to day.

And that may make it a little easier to sit back and enjoy the bounty when markets make new highs.

Find more commentary and insights on personal finance and investing in our past blog posts, eBooks and podcast on the website of PWL Capital’s Parkyn-Doyon La Rochelle team and on our Capital Topics website. 

TAKE ADVANTAGE OF THE EXPERTISE OF JAMES PARKYN, Portfolio Manager at PWL Capital Montreal to determine the best solution for you.

Patience and a focus on the long run

Patience and a focus on the long run

By James Parkyn - PWL Capital - Montreal

How to invest the Warren Buffett way—lessons from the latest Berkshire letter

Warren Buffett’s letters to shareholders are always packed with brilliant investing wisdom and fascinating insights. And this year’s is no different.

Buffett is the world’s most famous stock investor for a good reason. He grew a struggling New England textile manufacturer into a massive conglomerate that today is the seventh-largest U.S. company by market value—over $870 billion as of mid-June. Along the way, Buffett has used the annual Berkshire Hathaway shareholder letter to document the nuts and bolts of his success since 1965.

At PWL, we like to follow Buffett because we share his focus on a long-term investor’s mindset—meaning buying and holding as long as it is sensible to do so. I also talk about Buffett’s most recent shareholder letter in my latest Capital Topics podcast with François Doyon La Rochelle

Charlie Munger was Berkshire’s “architect”

Buffett started this year’s letter with a loving tribute to his longtime friend and business partner Charlie Munger, who died in November just 33 days shy of his 100th birthday.

Buffett, 93, describes Munger as his “part older brother, part loving father” who repeatedly “jerked me back to sanity when my old habits surfaced.” Munger was the “architect” of Berkshire, while Buffett “acted as the ‘general contractor’ to carry out the day-by-day construction of his vision. Charlie never sought to take credit for his role as creator but instead let me take the bows and receive the accolades,” he writes.

“Though I have long been in charge of the construction crew; Charlie should forever be credited with being the architect.”

Apple gains illustrate strategy

The Berkshire philosophy based on Munger’s vision is simple. Success comes from patiently riding out market volatility and holding positions for the long term, not trying to time the market.

Berkshire’s investment in Apple is a great example illustrating the approach. Berkshire came to Apple fairly late, buying its initial position only in 2016 and purchasing $36 billion (figures in USD) of Apple stock over the next three years. The investment paid off astonishingly well. As of May, Berkshire’s stake had soared in value to $157 billion, the Wall Street Journal reported .

“Berkshire is sitting on about $120 billion in paper gains, likely the most money ever made by an investor or a firm from a single stock. Nothing in Buffett’s long career comes close,” the newspaper said.

Berkshire has made an annualized return of over 26% from Apple including dividends—compared to a 12.9% gain for the S&P 500 during the same period.al-gains taxes will be a disincentive. Given Canada’s deepening productivity woes, it is precisely the wrong policy.”

Stock-picking “harder than you would think”

Buffett’s Apple investment shows the value of holding for the long run and ignoring the short-term volatility that the stock has seen over the years.

At the same time, lest anyone come away thinking the Apple story is a great argument for stock-picking, Buffett warns strongly against such a conclusion.

“Within capitalism, some businesses will flourish for a very long time while others will prove to be sinkholes,” he writes. “It’s harder than you would think to predict which will be the winners and losers. And those who tell you they know the answer are usually either self-delusional or snake-oil salesmen.”

Upside limited

Buffett’s letter includes a good example of the risks of stock-picking. He describes “severe earnings disappointment” at Berkshire Hathaway Energy—the company’s 100%-owned utilities and energy investment, which encountered significant regulatory and other issues last year.

Buffett acknowledges that he and his partners “did not anticipate or even consider” these issues and “made a costly mistake in not doing so.”

And despite Berkshire’s own meteoric growth, he warns that the gains aren’t likely to repeat in future: “We have no possibility of eye-popping performance.” The company is in a way a victim of its own success; as Buffett has warned in the past, “A high growth rate eventually forges its own anchor.”

“Patience pays”

Buffett himself is famous for suggesting that investors invest passively and broadly for the long term and avoid investment funds with high fees. As he puts it in his shareholder letter, “Patience pays.”

At PWL, we couldn’t agree more. Our own approach is to invest passively in a broadly diversified portfolio using evidence-based strategies. And this has meant that through our ownership of broad index funds, we’ve owned Apple stock even longer than Warren Buffett!

An investor’s mindset, a long-term focus, patience—the essence of what Buffett calls his “common sense” approach rooted in his birthplace of Omaha, Nebraska—are ideas we can all benefit from.

Find more commentary and insights on personal finance and investing in our past blog posts, eBooks and podcast on the website of PWL Capital’s Parkyn-Doyon La Rochelle team and on our Capital Topics website.

Read more about Charlie Munger in the book Poor Charlie’s Almanac: The Wit and Wisdom of Charles T. Munger, now in its fourth edition.

TAKE ADVANTAGE OF THE EXPERTISE OF JAMES PARKYN, Portfolio Manager at PWL Capital Montreal to determine the best solution for you.

Remember these lessons from market history to build your wealth

Remember these lessons from market history to build your wealth

By James Parkyn

Readers of this blog will know the importance we give to taking a long-term perspective on the markets.

That’s why each year we review the summary of the UBS Global Investment Returns Yearbook. The yearbook is a remarkable resource that looks at historical returns from 35 global markets back to 1900.

This year’s edition is the 25th. Historically, it was published by the Credit Suisse Research Institute and authored in collaboration with Paul Marsh and Mike Staunton of the London Business School and Elroy Dimson of Cambridge University. We’re grateful that UBS decided to continue its production and the collaboration with its authors after merging with Credit Suisse in 2023.

One of the topics explored in this year’s edition is investment risk and the extremes of global market performance—both good and bad—dating back to 1900.

Investors take risk to earn returns, but sometimes market volatility can test the nerves of even the most experienced investor. That was certainly the case in 2022, one of the worst years for stock and bond returns.

Indeed, the yearbook shows that U.S. government bond performance in 2022 adjusted for inflation was the worst since 1900 by a margin of about 15 percentage points. The real return for U.S. bonds was about -35% versus an average historical return of 2.2%. Unfortunately, stock returns were also dismal in 2022. The U.S. stock market generated a real return of about -30% versus an average of 8.4%.

It’s unusual for bonds to be more volatile than stocks as we see in the data provided by the yearbook. The six worst episodes for stock market investors were the 1929 Wall Street crash and Great Depression, the 1973-74 oil shock and recession, the popping of the dot.com bubble in 2000-02 and the global financial crisis of 2008-09.

Since the turn of the century, we’ve had our fair share of tough times. The yearbook notes: “In its 24-year life, the 21st century already has the dubious honor of hosting four bear markets, two of which ranked among the four worst in history.”

While this observation is enough to give any investor pause about the riskiness of stocks, it’s important keep sight of two lessons from market history.

First, stocks have always recovered from bear markets and gone on to reach new highs. However, the time to recovery has varied greatly.

In the U.S. stock market—by far the largest in the world—the recovery has occurred in a matter of months, as was the case after the COVID bear market of 2020, or over a period of years, especially if inflation is taken into account.

For example, after the tech bubble burst in March 2000, it took seven and a half years from the start of the bear market to full recovery in July 2007. Soon after, the financial crisis hit, causing another collapse. This time, it took four years for the market to recover. Together, the two bear markets made up what’s know as the lost decade in U.S. stocks.

The second lesson is that the good times in the stock market tend to last longer than the bad times and generate much better gains than the losses experienced during bear markets. The yearbook provides data on four “golden ages” for the stock market investors, each covering a decade. They were the recoveries following the first and second world wars, the expansionary 1980s and the 1990s tech boom.

Real equity returns in the 1980-89 period were 357% in the U.S. market and 247% globally. The 1990-99 tech boom produced 276% gain in the U.S. and 114% globally (a number dragged down by poor performance in Japan). The conclusion? To participate in market recoveries and benefit from the good times, you must remain invested through the shorter, but painful bad times.

As we saw in a recent blog post, stocks are not risk-free even over long periods, but they give you the best chance to outpace inflation and increase your wealth in real terms. Global diversification and disciplined rebalancing will soften the blow of negative periods in the markets and allow you to enjoy the longer, more profitable upsides.

If you’ve been investing for some time, you’ve already experienced both good and bad periods in the markets. When the next bear market occurs, it’s important to recall market history as well as your own personal experience. Those reflections will help give you the confidence to remain patient and avoid missing the next upswing.

For more commentary and insights on investing and personal finance, be sure to listen to our latest Capital Topics podcast and subscribe to never miss an episode. And download your free copy of our popular eBook Seven Deadly Sins of Investing. bscribe to never miss an episode.