Uncertainty can be liberating - here’s how to profit from it

As Woody Allen said, riffing on an old Yiddish proverb, ‘if you want to make God laugh, tell him your plans’. This is true of life in general, but it is particularly relevant to investors because it applies on two levels. First, we don’t know what’s going to happen; second, even if we did, the market’s response would most likely surprise us.

I’m reminded of this when I read predictions about the US Presidential election. Harris or Trump: what it means for your investments. The truth is we don’t know who will win this knife-edge vote and, even were we to, we would be foolish to build an investment strategy on that knowledge. In the two years following Donald Trump’s 2016 election win, the S&P 500 rose 30%. That was not the consensus view the day after the election.

The longer I do this, the more I understand how little we really know. Which you might think would be a worry. But it is the opposite. The lack of control is liberating. It allows you to hope for the best and prepare for the worst, which is a good starting point.

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The future is uncertain. Five years ago, I was enjoying breakfast in a peaceful Beirut with someone who was then but no longer is my wife while reading about the suspension of the Woodford Equity Income Fund. In June 2019, what lay ahead for Lebanon, my marriage and the UK’s most popular investment was unknown and unpredictable.

There were many other things we didn’t know about in 2019, something that came home to me as I did some tedious regulatory admin ahead of a presentation I gave yesterday to our investors. When I stand up in front of a chart showing the performance of any investment, FCA rules say I have to also show what happened to that investment over five consecutive annual periods. Your eyes are likely to glaze over, but the numbers hold an important lesson for us about uncertainty.

The five years for the chart I was preparing this week began on 1 October 2019. It has been a period of ups and downs, wildly divergent performances and, overall, positive investment returns. Looking back from here, it now makes sense, but how much of what happened over the past half a decade was predictable at the outset? Very little.

In the five years since October 2019 we have experienced: a global pandemic that locked us up for weeks on end and fractured supply chains; a long and bloody war on Europe’s eastern border and the resurgence of a long-running conflict in the Middle East; the worst inflationary spike since the 1970s and the end of the post-financial-crisis cheap money era; a splintering of global trade and the retreat of globalisation; the biggest rightward shift in politics since the second world war; and the emergence of a potentially world-changing technology in AI.

Had we known all of that was coming down the track in 2019, how might we have expected markets to respond and how might we, therefore, have invested our money? The first mistake we would have made, I suspect, would have been to invest with an over-abundance of caution. The best-performing stock market in the ten years prior to 2019 had been, by a country mile, the US. Rotating out of the S&P 500 and Nasdaq might have seemed a sensible precaution. It would not have been. In the past five years, the US benchmark has doubled while apparently safe government bonds have gone modestly backwards.

Foresight about the wars in Ukraine and the Middle East might quite reasonably have led you to expect a surge in the oil price and a return to the stagflation we endured fifty years ago. In reality, the spike in inflation was short-lived and the talk in both China and Europe is now of deflation. The oil price did rise sharply for a while, but it has fallen by a third over the past two years.

Had you correctly foreseen the dramatic rise in interest rates in 2022 and 2023, would you have predicted the outperformance of technology shares, whose long growth trajectories are made more valuable by lower-for-longer interest rates? Only if you had simultaneously forecast the market’s love affair with AI, which I for one had not given a moment’s thought to in 2019. Judging by Nvidia’s share price between 2019 and 2022, nor had anyone else.

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So, we know little. We don’t know what’s going to happen and we don’t know how investors will react when it does. Faced with this uncertainty, what can we do? Two things.

First, we can avoid making big bets on regions, sectors or asset classes. We can kid ourselves we saw the winners ahead of time. More likely, we got lucky. The cure for the absence of foresight is diversification. Put your eggs in plenty of baskets, because you will surely drop one or two along the way.

Second, we can avoid trying to time the ups and downs of the market. We won’t get it right. But if we invest regularly, through the cycle, that won’t matter because we will automatically put some of our money to work at the bottom.

This is not a counsel of despair. Far from it. The real lesson from the past five years is that despite everything that we’ve endured since 2019, financial markets have continued to illustrate the ‘triumph of the optimists’. By all means have a plan, but write it in pencil.

This article was originally published in The Telegraph.

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