“The market is not a very accommodating machine; it won’t provide high returns just because you need them.” – Peter Bernstein
As I’ve been discussing over the past year or so (see here, here, here, here and here), there have been a number of high profile predictions made for lower than average returns in the financial markets over the coming decade because of low interest rates on bonds and above average valuations on stocks.
The arguments are compelling and I like to err on the side of conservatism when setting performance expectations, so I think it makes sense for investors to pay attention to some of these claims. But the funny part it that rarely, if ever, will you hear a portfolio manager or investor claim that they themselves will experience lower than average returns.
The common refrain goes something like this: Have fun earning paltry market returns from these levels. To which my response would be: Where exactly do these people think their returns will come from? It’s not like it all the sudden becomes easier to beat the market if we do in fact see a lower return environment. Everyone is fishing in the same pond.
Here are some of the rebuttals you’ll often hear from those who think they’ll be immune from the possibility of below average market returns:
- I’ll just pick the best stocks.
- I’ll be able to nail the market’s reaction to the ongoing Greek crisis.
- I’ll be able to jump in and out of bonds and call the next big move in the interest rate cycle.
- I’ll just short the market before it starts to fall during the next bear market.
- I’ll go to cash before things really get out of hand.
- I’ll just pick top quartile funds.
- I’ll just listen to my favorite hedge fund manager who will surely tell me when to get out of the market.
- I’ll just be fearful when others are greedy.
- I’ll just use leverage to juice my returns.
- I’ll be much better at choosing securities when things get rough than I have been during this bull market.
- I’ll be able to rotate into the best performing sectors ahead of time.
- I’ll be able to follow my foolproof system that crushed the market in my elaborate back-test.
- I’ll be able to pick the top performing asset classes in advance.
- I’ll see the next recession coming.
- I’ll change my style for whatever the market environment calls for.
I’m not delusional. Some investors will be able to thread the needle and pull it off. But there are also a large number of investors who are delusional, because they’re making the assumption that they’ll be the ones who can pull it off, when in fact only a very small number of people can. There’s a seemingly endless supply of investors out there who try again and again to outsmart the markets, but only end up outsmarting themselves.
The only reason certain investment strategies succeed over time is because so many investors try and fail at this laundry list of hopeful tactics. But this is a good thing because it’s part of what makes the markets function. It’s unfortunate some investors won’t do as well as others, but there are always going to be investors who will benefit from the mistakes of others.
In the seemingly never-ending debate on the efficient market hypothesis, many point to the fact that so few investors are able to beat the market over the long-term as proof of the market’s efficiency. I look at these stats from a completely different angle. I view the fact that there are so many investors out there who assume that they will be one of the few who will beat the market over the long-term as a sign of how inefficient human nature can be. If markets were truly efficient, not nearly as many investors would try to outperform.
I’m not saying there are no good active managers out there. That’s just not true. I know for a fact that there are active managers who can and will beat the markets. What I am saying is that there are far more investors out there who believe that they can and will beat the market, when the weight of the historical evidence, and the simple zero sum nature of the markets, tells us otherwise.
A number of investors have been proclaiming that they can’t wait for this Fed-induced bull market to end so they can finally utilize their investing prowess to destroy the market. Some strategies are geared towards protecting capital on the downside, so for some this will be true. It’s good to have confidence in your process, but many of these people have delusional expectations about their own investing abilities. Investors hoping for a low returning market to prove themselves should be careful what they wish for. There is no such thing as an easy market to invest in.
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