This year has been very eventful for all investors. Political and economic risks have been extremely high, which may have impacted on your investment decisions in some way, shape or form.
However, the political and economic outlook is always subject to uncertainty. Threats to growth are omnipresent. Likewise, potential catalysts that could have a positive impact on the stock market can always be found.
In my view, since there an infinite number of variables that can affect stock prices, it is impossible to determine how economic or political change will impact the performance of specific companies and the wider stock market.
Therefore, using political and economic forecasts to make investment decisions seems to be illogical. If they can't be predicted accurately, and their impact on shares is also a known unknown, it seems to make more sense to simply ignore them.
Sticking with a simple strategy
A long-term standpoint makes it easier to ignore political and economic change. History shows that periods of weak economic performance or heightened political uncertainty never last for a prolonged period of time. Often, they affect the short-term performance of the stock market, which then goes on to recover. Investors who are unconcerned about the short-term performance of their portfolio are less likely to be influenced by factors that may not be relevant five or ten years further down the line.
Likewise, a value investing strategy that uses a bottom-up approach, in terms of assessing businesses rather than the political or economic outlook, may lead to efficient capital allocation. Put simply, a quality stock may be worth buying when it trades at a discount to its intrinsic value whatever the economic or political landscape. Even if it experiences high volatility in the short run, a quality company purchased at a fair price can go on to deliver high returns in the long term.
Learning from Buffett
Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) chairman Warren Buffett (Trades, Portfolio) highlighted these points in his 1994 letter to shareholders. At that time, the economy was still recovering from the early 1990s slowdown:
We will continue to ignore political and economic forecasts, which are an expensive distraction for many investors and businessmen. Thirty years ago, no one could have foreseen the huge expansion of the Vietnam War, wage and price controls, two oil shocks, the resignation of a president, the dissolution of the Soviet Union, a one-day drop in the Dow of 508 points, or treasury bill yields fluctuating between 2.8% and 17.4%... But, surprise - none of these blockbuster events made the slightest dent in Ben Graham's investment principles. Nor did they render unsound the negotiated purchases of fine businesses at sensible prices… A different set of major shocks is sure to occur in the next 30 years. We will neither try to predict these nor to profit from them. If we can identify businesses similar to those we have purchased in the past, external surprises will have little effect on our long-term results.
I think Buffett's words are very relevant in today's stock market environment. Economic and political uncertainty may seem to be high heading into 2021. However, there has rarely been a time when the stock market has faced no threats to its future prospects. Therefore, seeking to predict how they will impact on stock prices over the next year may be an unproductive use of your time.
Instead, seeking to identify quality businesses when they trade at fair prices could be a better idea. Even though some large-cap technology companies are trading on high earnings multiples, other companies continue to offer wide margins of safety. Using a value investing approach to identify them may allow an investor to capitalize on rising stock prices over the long run.
Disclosure: The author has no position in any stocks mentioned.
Read more here:
- Lessons on Change From Warren Buffett's 1986 Letter to Shareholders
- Howard Marks: A Bear Market Is Never Far Away
- Warren Buffett: Don't Dance to the Tune of Speculation
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