It's that time of year when many investors are tempted to make predictions and forecasts about how the stock market will perform in 2021.
Some investors may be feeling upbeat about the outlook for equities after the stock market's 65% rise since March. Others may be cautious about today's rich valuations due to the ongoing pandemic and social and political tensions.
In my view, there is little value in trying to predict the future. The past 12 months serve as evidence of this. Nobody accurately predicted the stock market's fall in the first quarter of 2020, as well as its subsequent surge to a new record high.
Therefore, I think a more productive use of the investor's time is to focus more on company fundamentals to find quality businesses that trade at fair prices.
Predictions versus company fundamentals
Predicting the future performance of shares is impossible because of the wide range of variables that can impact the stock market's performance. For instance, the Federal Reserve's stance, changes in fiscal policy and events such as the Covid-19 pandemic are all known unknowns that cannot be accurately forecast.
Alongside them, unforeseen events can have a positive or negative impact on investor sentiment. Trying to forecast unpredictable events is, by its very nature, unlikely to be a productive use of your time.
Therefore, I believe a focus on company fundamentals leads to a more efficient capital allocation. For instance, assessing a company's economic moat can provide an insight into how it could cope with a range of trading conditions that may be ahead in 2021. Likewise, determining whether it offers a margin of safety can help protect an investor during a potential bear market. It can also equate to higher returns versus overvalued stocks if the current bull market persists through the next 12 months.
Peter Lynch on the value of forecasting
Peter Lynch did not try to predict the future when managing the Magellan fund from 1977 to 1990. In that time, the fund recorded annualized returns of 29%. It outperformed the S&P 500 on an annual basis over 80% of the time. When discussing the value of forecasting, he has previously stated his preference for analyzing company fundamentals:
"Nobody can predict interest rates, the future direction of the economy or the stock market. Dismiss all such forecasts and concentrate on what's actually happening to the companies in which you've invested."
In my opinion, Lynch's views act as a valuable reminder as investors look ahead to a new calendar year. Making forecasts is easy. However, their accuracy and value in determining how to allocate capital has historically proved to be limited.
Instead of having a bullish or bearish stance on the stock market, buying quality companies at fair prices could be a more efficient strategy. Ultimately, nobody knows how the stock market will perform over any time period. However, a value investing strategy can maximize returns should today's bull market continue. It can also help to avoid richly-valued companies that may be among the hardest hit stocks when the next bear market eventually comes along.
Read more here:
- Howard Marks: Overpaying for Stocks Is a Dangerous Game
- Seth Klarman: Mixing Investing with Emotions Does Not Equal Success
- Warren Buffett: Don't Worry About Politics or the Economy
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