Investors have once again proven they are not smarter than the market. There is no shame in this, as the talking heads of the business media have proven the same.
At the beginning of 2011, "common knowledge" maintained the Canadian economy and its stock market would outperform that of the United States.
Why is it, then, that from January 1, 2011 to April 30, 2012, U.S. stocks, represented by the S&P 500 Total Return Index, grew by 13.15 per cent, while Canadian stocks, represented by the S&P TSX Total Return Index, lost 5.27 per cent?
The answer lies in the fact that investors knew how poorly the U.S. economy was doing and priced its stocks down to the point where they could expect a positive return going forward.
You see, although investors are not smarter than the market, they are also not stupid. Why in the world would they hold stocks at a lower price if they did not expect a positive return?
Other investors held Canadian stocks at their higher prices, as their positive expectations warranted a higher price. No one had a crystal ball though. The news about the U.S. ended up being about the same as expected and investors were rewarded accordingly.
The news about Canadian stocks on the other hand ended up being worse than expected and Canadian stocks underperformed.
Expectations of the economy bear very little relationship to how stock markets will perform.
We're back to the same old reality. We are no smarter than the markets. Lacking knowledge of the future, we cannot consistently pick winning stocks. Concentrating our portfolios into any particular sector simply increases our risk and hence we must diversify in as many ways possible.
What's a person to do?
First, ignore those who are trying to tell you what the market will do in the short to mid-term. They are lying. They simply do not know. Financial science and logic back me up on this.
Next, I would pay attention to the scientists rather than the salesmen. For a sampling of deep investment thought, Google the following names: Eugene Fama, Kenneth French, Harry Markowitz and William F. Sharpe. I would also read Warren Buffett's Annual Reports on the Berkshire Hathaway site. Your insomnia will miraculously be cured.
Then, work with an advisor who understands financial truth and diversify according to your unique risk tolerances by asset class, by geography, by size of company, by valuation (growth or value stocks) and across every possible industry sector available.
If you want tax-efficient returns that are better than term deposits offer, you must be prepared to take manageable levels of risk and be a long term believer in free enterprise.
Richard Vetter, BA, CFP, CLU, ChFC, is a senior financial advisor and branch manager with WealthSmart Financial Group.
