With 2016 Approaching, How Should You Invest For The Year Ahead?

We’re less than a month to 2016. And what a topsy-turvy year 2015 has so far been for stock markets elsewhere as well as in Singapore.

Our local stock market benchmark, the Straits Times Index (SGX: ^STI), had climbed to a seven-year high back in April. But alas, that good feeling didn’t last long with the index now sitting below 2,900.

With a lack lustre market this year, it’s likely, in my view, that there are many investors who would want some guidance on what to do and expect for 2016. There won’t be any shortage of professionals in the finance industry who are happy to meet that demand.

In fact, this is the season for stock market forecasts and predictions, when ‘market strategists’ start firing up their spreadsheets to crunch the numbers and divine where the market will be at the end of 2016. But, don’t listen to them.

Why? Consider the following from my colleague, Morgan Housel:

“This is embarrassing.

There are 22 “chief market strategists” at Wall Street’s biggest banks and investment firms…

…One of their most important — and certainly highest-profile — jobs is forecasting what the stock market will do over the next year. Strategists do this every January by predicting where the S&P 500 will close on Dec. 31.

You won’t be shocked to learn their track record isn’t perfect. But you might be surprised at how disastrously bad it is. I certainly was…

…Here’s the average strategist’s forecast versus the actual S&PP 500 performance since 2000:

S&P 500 forecasts

Source: Birinyi Associates, S&P Capital IQ

Some quick math shows the strategists’ forecasts were off by an average of 14.7 percentage points per year.”

The chart Morgan made was for the U.S. market and involved forecasts made by American financial institutions. So, there’s certainly a limit to its usefulness in describing the state of market forecasts in Singapore. But, what it shows is how difficult it can be to get short-term market forecasts right.

The strategists, Morgan wrote, “have access to the best information, the smartest economists and teams of brilliant analysts. They talk to the largest investors in the world. They work hard. They are paid lots of money.” And yet, they’re no better than a coin flip.

I have yet to see any long-term data on how short-term stock market forecasts have fared in Singapore, but the limited sample size I have does not paint a good picture: In December 2014, both UOB and DBS had targeted the Straits Times Index to close 2015 at 3,600 points. Unless the index goes on to achieve a monstrous rally this month, the forecasts will be way off base come the end of 2015.

But, just why is it so tough to get 12-month market forecasts right? One reason, in my opinion, is that the stock market is paradoxically easier to forecast over the long-term future than it is over the short-term.

This can be seen in the two charts below. The first plots the returns of the S&P 500, an important U.S. stock market barometer, against its starting valuation for a one-year holding period.

Chart 1 - Average annual returns of S&P 500 for 1 year holding period

Source: Robert Shiller; author’s calculations

The data used in the chart stretches from 1871 to 2013, so we have more than 100 years’ worth of market history. What it shows is essentially randomness: How cheap or expensive stocks are today can hardly tell you anything important about what they are going to do a year later.

Now, let’s look at the second chart. It uses the same set of data, but this time, it plots the S&P 500’s returns against its starting valuation for a 10 year holding period.

Chart 2 - Average annual returns of S&P 500 for 10 year holding period

Source: Robert Shiller; author’s calculations

A clear trend emerges: You’re more likely than not to do well if you buy stocks when they’re cheap and hold them for the long-term.

With this in mind, what can investors expect in 2016 from the stock market? Your guess is as good as mine. But, that doesn’t mean investors can’t invest well. We can still stick to what has worked over time: Investing for the long-term when valuations are sensible. Everything else is just noise.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any company mentioned.