Coca-Cola is fighting 12 consecutive years of soda consumption decline. Its stock is at an all-time high.
Tesla is changing the world, and orders for its new car are off the charts. Its stock is lower than it was 18 months ago.
Cigarette consumption has dropped 44% since 1981. Altria stock is up 71,000% since 1981.
WalMart net income has tripled since 2000. Its stock has lost 1.5% since 2000.
Apple has earned almost a quarter trillion dollars of profit since 2012. Its stock has barely budged.
Amazon's profits round to zero since 2012. Its stock has tripled.
2009 was one of the worst years for the economy in a century. The market rose 27%.
2015 was a good year for the economy. The market rose 1%.
Brazil's economy is a disaster. Its stock market is flat over the last two years.
America is enjoying the longest streak of low unemployment claims in four decades. Its stock market is also flat over the last two years.
And so on.
I'm fascinated with the problem of why really smart people have such a hard time predicting the future. It's mostly because the future is more random than we think. But it's also because future performance (like earnings and economic growth) doesn't tell you half of what you need to know to predict future outcomes. Outcomes are determined by performance within the context of expectations, with importance heavily weighted toward the latter. And if predicting future performance is hard, calibrating them against expectations is close to sorcery.
Even if you accurately forecast future performance, predicting the outcome from that performance requires answering two questions:
- Are current expectations reasonable?
- What will future expectations be?
The first is possible to answer, but pretty hard. We can look at sentiment and valuations to gauge, based on past trends, whether the current mood seems reasonable. But disagreeing with popular sentiment is easier said than done. Few things feel better than fitting in, and having a viewpoint that goes against everyone around you is a mental battle not one person in a ten can maintain for long. Rather than identifying extremes in current sentiment, it's easier to justify the market's mood no matter what it is. Billionaire investor Howard Marks once wrote:
The problem is that extraordinary performance comes only from correct nonconsensual forecasts, but nonconsensual forecasts are hard to make, hard to make correctly, and hard to act on.
The second – predicting future expectations – is even harder. To know where stock prices will be in five years, I have to know what mood people will be in five years from now. Which is as ambitious as it sounds. Ask yourself what kind of mood you yourself will be in in April 2021, and you'll shake your head in laughter. Ask what kind of mood seven billion strangers will be in in April 2021 – that mood, of course, will determine stock prices in five years -- and it's hard to keep a straight face. This is where the disconnect between performance and outcomes occurs: Accurately predicting five years of economic growth might not do much for the stock market if, five years from now, people are worried about the future five years from then.
As Ben Graham said, "In the short run, the market is a voting machine. But in the long run, it is a weighing machine." Even if future markets are gloomier than they are now, rising profits and compounding business assets can leave investors with a positive return. This "weighing" is why true long-term investing isn't gambling. Real value is created, even if we don't know exactly when it will flow to shareholders' pockets.
But the more precise we try to forecast, the more we rely on predicting emotions and expectations. In a world where analysts focus most of their time analyzing performance – what earnings will do, or what the economy will do – and it's no wonder we struggle to predict outcomes.