When investing, never trust predictions

1. What needs to be done is not prediction, but risk assessment

For humans, the world is difficult to predict, mainly because the future is unpredictable.

We live in a complex, interconnected world, and no one knows for sure what will happen next.

Looking back at recent major events in the market, any real assessment would agree; they are unpredictable.

No one specifically predicted the COVID-19 outbreak, and we don't know where it began. In fact, looking back in the past, we haven't even fully understood its origin.

The amazing bull market that followed also seemed unpredictable. The stock market experienced a crazy bull market after the global lockdown, which was unprecedented in history.

Other market drivers are not non-artificial “black swans” (like COVID-19), but rather a decision made by a small group of people, which could play any driving role.

Although it is impossible to predict outbreaks, when you carefully assess risk, you can estimate the likelihood of such a situation occurring, even if you don't know exactly when or how it will occur.

However, these are assessments of risk, not predictions. Because you know that stock prices are affected by widespread and unpredictable events, you need to make sure you don't increase leverage, and you also know that a 50% drop may occur.

If you trust the predictions you make about your portfolio (or predictions made by others), then you're risking your own money.

Therefore, when we plan for the 2022 column, we instead do risk assessments (rather than predictions) to decide how to make a well-allocated and risk-resistant investment portfolio.

We'll try to figure out all the potential events that might happen and find potential rewards without having to take big risks.

2. Predictive solutions: turning complex predictions into simple forecasts

As investors, we prefer to know companies and decide which corporate shares we want to hold for a long time. This is much easier than a macroeconomic operation.

If you can buy at a reasonable price and hold it for a reasonable period of time, you can accumulate real wealth.

We also use a portfolio approach that lets you invest based on growth potential rather than predictions.

For example, we bet on high-return Bitcoin (BTC-USD) (up 331%) and software services stocks such as Asana (ASAN) and Sea Limited (SE) in our simulated portfolio, which rose by 183% and 407%, respectively.

All of these investments have had poor returns over the past few months, and we have to admit, we didn't anticipate that. However, the rewards of holding them for a long time are impressive, and we are willing to endure this kind of volatility and wait for them to pay off.

We can hold small positions and reap big profits over time, even if we can't accurately predict the monthly trend.

You need a baseline to anticipate the future. Compared to making complex predictions, simply looking at whether the economy will be constructive and whether valuations will rise is more helpful to you. If there are no other reasons, a simple outlook will keep you from being overconfident.

With that in mind, we can now look at an indicator to form the opinion of this article.

3. A method for forming a benchmark: look at the yield curve

We are optimistic and will continue to invest in the stock market. But we do see that the yield curve hidden beneath the surface reveals to us that it makes sense to be cautious about bonds.

The yield curve assesses the difference in interest rates between short-term bonds and long-term bonds.

When interest spreads “reverse,” that is, when interest rates on short-term bonds are higher than long-term bonds, this is a strong indicator of an impending recession. This news also made headlines in the financial media.

At other times, however, the yield curve only received attention in the bond market, although it can still reveal a lot of information.

The yield curve is now flattening, which is not a good sign.

If you combine the interest rates for each maturing bond into a line, this curve is usually steep. Under normal circumstances, given the capital lockdown period and greater uncertainty in the future, bond investors would require 10-year bonds to yield higher than 2-year bonds.

This was true in early 2021, but now this curve is flattening. As shown in the chart below, the curve from March last year was steeper than it is now.

Or you can look at it from a different perspective. By looking at the interest rate difference between 2-year and 10-year treasury bonds, you can see that the yield curve has declined rapidly recently.

Overall, the yield curve has not reversed, but it is flattening.

The lower half of the chart above shows interest rates for 10-year and 2-year treasury bonds, respectively. We can see that the yield curve has leveled off, but this is only because short-term interest rates have risen (not because long-term interest rates have declined).

This is known as a “bear flattener (bear flattener),” which indicates that inflation will continue, so there is no focus on long-term bonds. This indicates that the Federal Reserve will raise interest rates and cause short-term interest rates to rise.

Neither outcome is good for bond-holding investors.

However, research data from investment management company Merrill Lynch Securities from 1976 to 2018 shows that this will benefit the stock market.

During the period when the bear market leveled off, the stock market had an annual return of 17.4%. In contrast, the average annual return over the entire study period was only 12.4%. This reflects the fact that stocks will continue to rise because there are no other areas worth investing in. This is why we hold fewer fixed income positions in our “full, profitable, and defensive” portfolios.

We will continue to pay attention to our benchmark for a strong economy this year, but we also need to understand that valuations are very high. We will then carefully balance your wealth based on dozens of potential assessments, risks, and opportunities.

While we strive to outperform the market, a well-allocated portfolio approach allows us to protect your wealth through position size and diversification, which cannot be done with a simple stock idea.

The key here is to understand that you don't need to predict how the market will work; you just need to avoid mistakes and bet on different prospects with the right combination.

Make the right investments for your health, wealth, and retirement.

Analyst: Dr. David Eifrig

Compiled by Samantha