Quarterly Update

Nathan Geraci is President of The ETF Store, Inc. and host of the weekly radio show “The ETF Store Show“.

“I try not to get involved in the business of prediction. It’s a quick way to look like an idiot.” – Award-winning author Warren Ellis

There is a natural human desire to know what the future holds.  If we could peer around the corner and see what lies ahead, we might be able to protect ourselves or perhaps capitalize on an opportunity.  The desire to predict the future is something innate and deeply rooted in all of us.  This is why predictions, and especially predictions from people appearing to know more than we do (so-called “experts”), can be so enticing.  However, if there is a single lesson learned from 2016, it is that you should not count on experts to get anything right.  Ditto for the wisdom of crowds.

From predictions of China’s economic demise to the Brexit (UK voting to leave the European Union) to the US presidential election, experts (and just about anyone else offering a prediction) had a rough year.  According to The Economist, on the day of the Brexit vote, UK betting markets “priced about an 85% likelihood that Britain would remain in the EU”.  On the day prior to the US election, Hillary Clinton winning the White House was nearly a foregone conclusion according to the polls.

Visual Capitalist

From an investment standpoint, even if you had a fully-functioning crystal ball and correctly predicted the outcomes of these major events, there existed a high likelihood you still would have failed to capitalize in the financial markets.  Recall that widespread expectations were that stocks would crater in the unlikely scenario of the UK voting to leave the EU.  While stocks did briefly dip following the UK’s decision to leave, they were nearly back to even just a few trading days later and 3% higher a month later.  A similar scenario unfolded with the US presidential election, where most experts predicted sharp stock declines if Donald Trump proved victorious.  Once again, while stock futures did plummet on election night as the unexpected results of the election became clear, stocks actually closed in positive territory the day after.  As a matter of fact, from the day following the election through the end of the year, the S&P 500 returned nearly 3.5% – now referred to as the “Trump bump”.

In the end, you might think of market predictions the same way you think about predictions for your favorite sports teams:  they can be fun, entertaining, and even informative at times – but they are usually worthless.  For our Kansas City-based clients, the warm glow from the Royals’ 2015 World Series title likely still exists.  At the beginning of that season, ESPN polled eighty-eight of their baseball “experts” and guess how many picked the Royals to win the AL Central?  Three.  Three out of eighty-eight analysts.  That was just to win their division, let alone the world championship.  Whether sports, politics, or financial markets, the bottom line is nobody has a crystal ball.  As economist Edgar R. Fiedler once said, “He who lives by the crystal ball soon learns to eat ground glass”.To recap:  Most experts incorrectly predicted the outcomes of major events in 2016.  Making matters worse, even if the outcomes of these events had been correctly predicted, financial markets reacted in a matter that went against expert consensus.  As it relates to the US presidential election, in last quarter’s commentary, we said “attempting to handicap the market reaction to either outcome is a fool’s errand”.  Taking action in your investment portfolio in 2016 based on expert predictions or the wisdom of crowds would likely have resulted in foregone returns, or even worse, booking losses at the most inopportune times.

Just because 2016 was a tough year for soothsayers, we are not expecting the prediction business to die anytime soon.  From rising interest rates to anticipated economic growth from Trump’s fiscal stimulus to the always present “higher market volatility” prediction, market and economic prognostications are already coming fast and furious.  Instead of relying on predictions, we subscribe to the time-tested investment philosophies of longer-term thinking, maintaining discipline, diversification, asset allocation, and minimizing investment costs.  No crystal ball is needed to provide us with a high level of confidence these will lead to investment success.

One last unrelated note:  A record $287 billion flowed into US-listed ETFs in 2016, while a record $359 billion dollars came out of actively managed mutual funds.  A massive sea change is occurring whereby investors are shunning expensive, chronically underperforming mutual funds and gravitating towards lower cost ETFs.  Matt Hougan, CEO at Inside ETFs, recently commented in the Financial Times:

“There is a manifest destiny for ETFs.  They are the structure that people will use to get exposure to securities in the future, and mutual funds will be banished to the dustbin, like typewriters have been replaced by computers.  It’s just a better technology and so it will come to replace funds over the next 20 years”.

For clients both new and old, we would like to take this opportunity to simply thank you for your trust and belief in our investment process.  Our firm was founded nearly nine years ago on the idea that there was a better way to invest.  It is highly rewarding to watch the landscape shift significantly towards our core investing values.  You are at the center of everything we do and we hope you will take some satisfaction in both the growth of ETFs and the growth of The ETF Store.  We wish you a happy, healthy, and prosperous New Year and, as always, please do not hesitate to contact your advisor with questions regarding your investment strategy or the markets.