Putting the Crystal Ball Aside
As investors, it is often tempting to try and predict how a business, industry, or the economy will perform in the future. After all, it is human nature to look for certainty in everyday life—that is why we check the weather before going on a trip or look at polls about upcoming electoral contests. Given that investing requires us to deal with several unknowns, many people tend to pay close attention to what economists, market strategists, and pundits have to say about what lies ahead, particularly during periods of elevated uncertainty.
In an attempt to provide clarity into the future, many analysts spend a significant amount of time and effort putting together economic and market forecasts, frequently using complex statistical models and sophisticated mathematical calculations. Though these projections tend to be based on historical economic or market data, they often prognosticate an array of different outcomes. While some analysts extrapolate past performance to make some form of prediction, others take more of a creative route, factoring in new assumptions about what they see happening down the road.
Even at the time of this writing, some economic forecasters have begun issuing warnings about the rising risk of a global recession. In contrast, others have presented a more sanguine outlook, citing robust consumer demand, higher business investment, and rising wages as factors keeping a flame under the recovery. Making projections has become a popular exercise in the investment community. In fact, many market participants believe that if they can accurately predict macroeconomic conditions—such as how many times the Fed will raise interest rates or where inflation will be by year-end—they will be able to position their portfolios effectively and capitalize on these trends.
The Importance of Humility in Investing
While building an investment strategy based on an economic outlook or market view may appeal to some people, we caution that doing so could carry unforeseen risks. As investors, we believe in exercising intellectual humility. This means we recognize that accurately and consistently predicting the probability of future outcomes is a very difficult task. Even the recent example of higher inflation is illustrative. Just 6-9 months ago, consensus forecasts for year-end U.S. CPI ranged from 2-3%. By late April, forecasts for CPI growth in 2022 increased to 6.5%, doubling the previous estimates from just a few months prior as seen below.1
Consumer Price Index (CPI) Year-End 2022 Forecast
*Annual growth rates are year-over-year
Source: FactSet estimates as of 5/1/2022
We acknowledge that predicting a metric as complex as U.S. CPI is extraordinarily difficult as it must take into account an enormous number of constantly changing variables. But that’s precisely the point. The fact that there is a high margin of error strikes us as a good argument for not relying on these forecasts to make investment decisions, and those forecasts are affected by various changing inputs that seem nearly impossible to predict with any accuracy.
Therefore, we believe that seeking to forecast the timing and magnitude of economic changes—and how they will interact in a fluid environment—may prove an inefficient use of an investor’s time and a risky foundation on which to base one’s capital allocation decisions. This is why Warren Buffett—considered one of the greatest investors of the 21st century—once stated that “forecasts may tell you a great deal about the forecasters, yet they tell you nothing about the future.”
Facing a volatile market backdrop and pressure from investors to provide clarity on the future, Buffett took the opportunity to write in his July 1966 letter to investors that he “was not in the business of predicting general stock market or business fluctuations.” Showcasing a high degree of self-awareness, he firmly stated that if investors thought he could do this, they should not be in the partnership. Since then, Buffett has remained a public skeptic of forecasts, explaining at the 1994 Berkshire Hathaway annual meeting that “you cannot get rich with a weather vane.”
Focusing on Businesses, not Predictions
One of the risks with building portfolios based on assumptions about the direction of the market or economy and only buying securities that fit that model lies in the opportunity cost of being wrong. Forecasters tend to recalibrate their original predictions—sometimes multiple times—as economic conditions change. Unlike forecasters, investors who have skin in the game could face hefty losses if they constantly readjust their portfolio’s positions to meet a new set of assumptions.
Some market participants believe they can successfully trade in and out of securities based on their ability to forecast economic conditions. For example, they may use a country’s Gross Domestic Product (GDP) to predict the future performance of that country’s stock market. However, as we will explore in the second part of this POV series, the economy and the market are vastly different, and their performance correlations have historically been weak.
At Polen Capital, our equity investment philosophy is not centered on accurately predicting or timing changes in the macro environment. Instead, we use a bottom-up approach and look for what we think are the most competitively advantaged, durable businesses in the world. As a result, our five equity research guardrails shown below often lead us to high-quality companies capable of thriving under different economic and market scenarios. Rather than basing our decision-making on forecasts, we approach investing with a business owner’s mentality, focusing solely on long-term fundamentals. Given the power of compounding over time, we believe that once we invest in great businesses, the best path forward is to stay the course through a long-term approach.
1 FactSet annual growth CPI year-over-year forecast estimates (as of 5/1/2022)
This information is provided for illustrative purposes only. Opinions and views expressed constitute the judgment of Polen Capital as of May 2022 may involve a number of assumptions and estimates which are not guaranteed, and are subject to change without notice or update. Although the information and any opinions or views given have been obtained from or based on sources believed to be reliable, no warranty or representation is made as to their correctness, completeness or accuracy. Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice, including any forward-looking estimates or statements which are based on certain expectations and assumptions. The views and strategies described may not be suitable for all clients. This document does not identify all the risks (direct or indirect) or other considerations which might be material to you when entering any financial transaction. Past performance does not guarantee future results and profitable results cannot be guaranteed.