Unexpected returns

Imagine in March 2020, right at the start of the global lockdown, an investment guru walks into your office and makes a prediction:

“I know the global equity market is down 30% and we’ve shut down economic activities globally, thanks to a horrible virus ravaging the world, yet around $10trillion will be wiped ON the value of the world’s best and brightest companies by the end of the year.”

She’d have been laughed out of the room.

Yet, this is exactly what happened. The only difference is no one predicted this. It would have been insane to.

All said:

  • The US market finished the year in record territory and with a 16% annual return for the S&P 500. At 33.9%, the maximum Intra-Year Drawdown in the S&P 500 during 2020 was the highest ever for a year that ended with a positive return.
  • Global developed markets, as measured by the MSCI World returned 14%
  • Emerging markets, as measured by the FTSE Emerging Markets Index, returned 15% for the year.

The genius of the most intelligent wealth creating machine ever invented in the history of mankind, aka the global equity market, confounded us all yet again.

Humans have a short memory. Looking at the equity market performance at the end of the year, it is easy to forget that in March, it really did feel like the end of the world.

I wrote an article in March of 2020, basically saying that “this type of decline in the capital market is a feature, not a bug. It’s part and parcel of investing. It may look and feel different but the latest decline, so far, is very well within the range of historical scenarios.”

I recall folks asking “but… but… what if you’re wrong? What if this time is really different, and the capital market never recovers from this?”

My response, published in April, was as direct as it was brutal “If we’re wrong, we’ll all be dead. It won’t matter much that our portfolios never recovered.”

To have dignified the question with any other response would have implied that the eventual, inevitable capital market recovery was ever in doubt.

The most unwanted capital market recovery of all time?

You’d be forgiven for thinking that when equity market did bounce back, the doubters and the naysayers would go quiet, at least for a time?

No, no, no. Not even that would appease them. They switched to the old ‘stock market-divorced-from-the-real-economy’ chestnut.

“Surely” they argued “the capital market is disconnected from reality. Or else, how could the equity market reach new highs, when our collective wellbeing, prosperity and freedom is threatened by an invisible enemy?”

Oh simpletons, the market owes you no explanation for its behaviours. Haven’t you heard it said of the market:

‘…there was no rational purpose in the activities which was not overlaid with an irrational one, no trick used by one person which others did not pay back with the same coin, so that, in this stock exchange business, one moved in a world of darkness which nobody wholly understood and no pen was able really to describe in all its intricacies

That line is from José Penso de la Vega’s Confusion of Confusions published in 1688 and is the oldest account of the workings of the Amsterdam stock exchange. It is as true today as it was over 300 years ago.

The genius of capital market is, we can’t always offer rational explanation even after the fact, let alone predict it.  As Michael Mauboussin noted “complex adaptive systems effectively obscure cause and effect. You can’t make predictions in any but the broadest and vaguest terms. … complexity doesn’t lend itself to tidy mathematics in the way that some traditional, linear financial models do.”

But if it makes you feel better to have some theory for why the market behaved the way it did in 2020, Dimensional had this to say:

“The market’s behavior suggests investors were looking past the short-term impact of the pandemic to assess the expected rebound of business activity and an eventual return to more-normal conditions. Seen through that lens, the rebound in share prices reflected a market that is always looking ahead, incorporating both current news and expectations of the future into stock prices.”


All I know is, if you tried to time the market and sold out in March, you likely paid a heavy price.

If you sat on your hands through one of the most dramatic bear markets in living memory, the market rewarded your patience. And if you’re one of the privileged few to have had a competent adviser who helped you stay the course, send them a flower with a thank you note.

So what should we expect in 2021?

Funny you should ask. You’ve clearly learned nothing my dear friend.

Those who were expecting some calm after the storm might already find themselves confounded by the events on the Capitol in the first few days of the year.

Expecting some kind of ‘normality’ to return to the capital market this year, for no other reason than the fact that last year was bumpy is akin to expecting the next coin flip to give you ‘Heads’, because the last one was ‘Tails’.

Sorry to disappoint but the market isn’t any more predictable now than it was last year.

The equity market isn’t obliged to deliver your expected return. If anything, it’s pretty adept at delivering unexpected return in any single year.

You’d have thought that peddlers of market forecasts would have learnt that lesson in 2020 and hung their boots. Alas, that’s not the case.

One reason is that the punters keep coming. The number of people who continue to entrust their family’s financial future and retirement to those who claim to have the ability to second-guess the financial markets is mind-boggling.

The second is that, more than any other domain, market forecasters are afflicted by a horrible decease that is Dunning-Kruger Effect - a cognitive bias in which people with low ability at a given task are prone to overestimate their ability at that task. Put bluntly,  market forecasters are notoriously incapable of objective evaluation of their competency levels. They never learn because they are incapable of learning. They’d do it again this year, next year and the one after. Forecasting nearly always tells you way more about the forecaster than about the future.