December 2016

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The human impulse to make predictions about future events is understandable, and is another thing that separates us from the rest of the animal kingdom (along with the need we have for meaning and purpose). I can’t imagine that my pet Border Collie ever worries about where her next meal will come from or if there will ever be another frisbee toss coming her way. But for us humans, there are any number of things we can choose to worry about, and that worry is always focused in the future. Hence, the unending quest to predict things, to reduce or eliminate the anxiety and fear which often accompanies uncertainty.

I marvel at the accuracy of weather forecasts, the fruit of years of sophisticated meteorological computer modelling, which most of us take for granted nowadays. This benefits us all. But even with such impressive advances in forecasting, we are sometimes prone to put too much stake in expert predictions based on complex statistical models. The recent U.S. Presidential Election stands as a good reminder of this. Right up to the night of the election, most election polls predicted Mrs. Clinton would emerge the victor over Mr. Trump.

Like many of you, I stayed up to watch the election results. I kept a close eye on the Dow Jones Industrial futures contract. At one point that evening, blue chip stocks were selling off by over 800 points. Now, several days later, as we discuss in the accompanying Market Observer Video, U.S. stocks are up significantly, with certain sectors like financials and industrials up significantly. Why?

Ironically, we can point to the experts again. Only this time, we’re not talking about political pundits but pundits from the world of investing. The reasoning is simple enough. If Mr. Trump can fulfill certain campaign promises, such as significant increased government spending on U.S. infrastructure improvement projects like roads, bridges and airports, certain industries and businesses will benefit from all that spending. It all sounds so logical. “Investors” then placed bets on those stocks, driving up stock prices, based on that prediction.

The problem with this line of thinking is that it more closely resembles short-term speculation rather than long-term investing. A moment of reflection surfaces many questions. What will the actual infrastructure spending look like? How quickly will the legislation get passed? Will it involve outright government contracts or funded through individual states? Will it have a private component? How will the architects and construction companies be chosen? How long will all of this take before any of it actually gets counted in the GDP calculation? (Does anyone remember the phrase “Shovel-ready projects”? Google it. It wasn’t that long ago.) Similar questions can be raised about the assumptions underlying the big run-up in financial services stocks.

The point of all this is to bring us back to something else mentioned in the accompanying video, that stock price valuations in the long run must be anchored to corporate profitability, and not on short-term speculation based on the thinly conceived predictions of so-called stock market “gurus”. It’s the growth in expected future cash flows from businesses that creates wealth in the form of increased stock prices.

So, the next time I notice my dog staring at me, I can be reasonably sure that she is not worried about how the predicted deregulation and certainty of rising interest rates will benefit commercial banks in the future. She probably just wants me to know that I forgot to feed her (again).