Investors are bombarded with news about the economy and the stock market’s recent performance every day. Trying to understand what’s going on can be a challenge because, at any given time, there may be no correlation between the real world and Wall Street.
Ralph Wagner, a well-known fund manager, and author, once stated this about the economy and the stock market:
A dog with an extremely long leash is running around New York City, scurrying in every direction. The dog’s owner is making her way to the Metropolitan Museum of Art from Columbus Circle via Central Park. “At any given time, it is impossible to predict which direction the dog will go.”
You know he’s heading northeast at an average speed of three miles per hour in the long run, though. ” That almost everyone in the dog-watching community seems to be focused on the dog rather than the owner is astonishment.”
This is a common analogy I use to explain the interplay between the economy and the stock market. To be a successful investor, you must be able to hold two contradictory ideas in your head at the same time and do so despite the discomfort that this can cause your brain.
At times when things are bad but not as bad as everyone thinks, and slowly, almost imperceptibly getting better is one of the most ironic aspects of investing. It’s a great time to buy discounted assets and take advantage of the abundance of opportunities that is right in front of us.
On the other hand, investing at a time when everyone agrees that things are great and that the gains will go on indefinitely is a bad idea. In the midst of this, we’re forced to pay a premium for assets and compete with a large number of buyers.
But most of the time, neither the economy nor the stock market is at its best or worst. As a general rule, the economy tends to follow a predictable path for years at a time, while the stock market is prone to erratic swings, based on the most recent news. There is a correlation between stock prices and the economy over longer periods of time, but there is absolutely no correlation between stock prices and the economy over shorter periods of time. In the end, every explanation is just an expert grasping at straws to put together a reasonable take on what happened and why it should have been obvious to everyone.
For the following reasons, long-term investors are not well served by incorporating economic forecasts into their investment plans:
- It is impossible to predict the future.
- A person who knows what will happen in a given year would still have to make educated guesses about how buyers and sellers will react and how investment markets’ sentiments will change, even if they know the future.
- The stock market has rallied many times when the economy has performed worse than expected. Some years saw strong economic data but weak stock prices. Then there’s everything in between that we’ve seen. None of these possibilities can be reliably predicted in advance.
Having a basic knowledge of the economy is a good thing to do. You can play the midway game of market bets based on this understanding.