It is also not enough to “simply” predict these outcomes as legendary bond investor Howard Marks often illustrates with his comments on second level thinking. To generate outsized returns, an investor must accurately predict the macroeconomic conditions and how businesses and then investments will respond to this environment. Marks believes this is exceptionally difficult (perhaps impossible) to do on a regular basis–a view that is consistent with other highly successful investors including Warren Buffett and Peter Lynch.

Most of these predictions have not borne fruit, supporting Buffett’s belief that “forecasts may tell you a great deal about the forecaster; they tell you nothing about the future.” Europe has managed an incredible transition away from Russian gas following the war in Ukraine, the United Kingdom has avoided a recession (despite more extreme inflationary pressure, particularly around energy costs), and locally, both house prices and gross domestic product (GDP) have continued to grind higher–albeit at a modest pace. The world’s largest economy, the United States, even recorded GDP growth of 4.9% year-on-year (YoY) in the third quarter–the fastest pace since 2021!

It’s similar to how journalists would find it difficult to attract readers to articles describing a healthy diet and relaxed lifestyle compared to those about the hidden risks of life that may cause a premature death.

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According to Charlie Bilello, since 1928, the S&P 500 has been in a drawdown over 71% of the time (using monthly data that includes the returns from dividends). Yet according to Investopedia, the average annualised return since 1957 (when the 500 stocks were adopted as an index to measure against) was approximately 10.15% through the end of 2022.The long-term return trends are clear and compelling. Yet the fear of loss can often deter or even overwhelm people from choosing to invest or staying invested. This is known as “loss aversion” (or occasionally Prospect Theory), and relates to the fact that investors feel the pain of losing a dollar more than they feel the pleasure of gaining a dollar of profits. This is one of several reasons why the average investor often underperforms the market.

To be more explicit, Morningstar says that “investors are using price changes as signalling mechanisms to make changes to their portfolio. This is at the heart of why these poor decisions are made.” Or as the so-called father of value investing Ben Graham once said, “the investor’s chief problem–and even his worst enemy–is likely to be himself.”In particular, Morningstar highlights that while a strong and growing economy is good for company profits, share prices often rally significantly in anticipation of a better economy. This can create “cognitive dissonance” for investors, meaning that it is hard for them to meld these two ideas.

It is also important to remember that a share price reflects the total discounted cash flows for a company for the rest of its existence. One particular year of profits can be important (particularly in the event of a huge loss or cash flow crunch), but it may also represent a fraction of the company’s worth–particularly if it is growing at a healthy clip. Unfortunately for investors, there is a long lead time between decisions and results, and the feedback loop isn’t particularly clear (unlike receiving an annual bonus at work, for example).

Yet one of the most damaging can be negativity and the fear of loss that prevents someone from investing or causes them to zig and zag at exactly the wrong time. We have seen how devastating this can be on returns with the demise of Hamish Douglass at Magellan, who took an extremely conservative view at the onset of the coronavirus pandemic.On the contrary, Buffett has held an almost ever-optimistic view about the future of America and the benefits of long-term share ownership. He focuses on the long-term increases in productivity and standard of living that continually drive the market higher and accepts the volatility that comes from inevitable recessions and market drawdowns. Buffett uses any moments of market pessimism to increase his long-term ownership of his favourite businesses.

In fact, when the market is fuelled with optimism (as it was during 2021 when “meme stock” trading was in vogue), this can often signal a short-term peak in valuations. The economy is strong, profit margins are high, and there are a host of new buyers for each stock as participation in the share market hits new highs–that is, the environment is about as good as it can get.

Conversely, it’s often said that the share market “climbs a wall of worry” in the early and mid stages of a recovery. The market continues to grind slowly but steadily higher amidst a host of negative news, before surging late in the cycle as optimism once again returns. Bank of America last week noted that ETF inflows surged, with the largest inflows in 11 months. When the negative headlines are busy generating clickbait, it’s important to keep in mind that the long-term trend of the share market is up.