Market forecasts are impossible – diversification will be essential for investors in 2025
“Diversification is the only armour against failing forecasts” - Karl Rogers, Chief Investment Officer, Elkstone
Price Predictions
It’s that time of year where institutions provide their 2025 price forecasts. Macro forecasting is near impossible. We shouldn’t put much weight in firm’s price predictions; price movements take in so many complex variables, including human behaviour. Not only does the forecast need to predict the correct data point, but the market reaction to the data point is of most importance.
Looking back over the past two years of price predictions from well known names, 2023 equity price predictions had a range of -4% to +25%, averaging +6%; - the outcome was actually +24%. Similarly, 2024 predictions had a range of -12% to +13% with an average of +2.4% - the outcome was more than double the highest prediction at+27%. At the time of writing, 2025 forecasts range from +2% to 15% – the outcome, anyone's guess!
Capital Flows & The Path of Least Resistance
There are two core concepts worth focusing on when it comes to market price movements: i.e the basic reason why prices increase, or decrease is because there are more dollars trying to buy then sell and vice versa and ii. there is a set amount of capital that is put to work within the markets and where it goes to is a function of the investment choices available.
The textbooks tell you fundamentals drive the price [they also assume market participants are rationale!], however market structure and dynamics have changed since the GFC. Capital flows are incredibly important and the significant shift to ETF/passive investments have changed the dynamics to put a higher weighting on capital flows – simply, there is a lot more capital flowing and that affects the prices.
Market capital flows tend to act like electricity – electricity can’t be stored or just disappear, so there’s a constant flow towards the path of least resistance. It’s a similar concept across the capital markets. There is a certain amount of capital out there that needs a home. There are institutional mandates that requires certain levels to be put to work in certain asset classes and there is a tap that magnifies this amount, often called ‘liquidity’ which is the money supply, that the Central Banks have been providing.
The Path of Least Resistance
It’s become clear through 2024 where the path of least resistance is and that has been both US equities and cash. This is driven by the relatively poorer economic outlook within Europe and Asia [wars, political risk, and investor and consumer sentiment] and so when the money must go somewhere, it’s been to the most resilient. Value investors will look at the US valuations [which are high] and compare to the likes of European valuations [which are low] and may infer that a rotation or return to the average must occur, but the execution is around a timing forecast. The valuations are low in Europe for a reason and significant macro changes are needed to alter that outlook. We are watching out for any macro changes that positively alters the outlook for Europe and challenge the path of least resistance to the US.
Can we have another big absolute year? Yes. There are significant amounts of cash being held in reserve. Berkshire holding more cash than it has ever done before comes to mind. This sidelined capital does need to be put to work at some stage. When it does, there will be significant price movements.
Cash & Bonds
Cash has been looking good in recent years as it’s been paying up to around $5% and €4%, respectively. Stickiness in inflation and Trump coming in office means that there is a strong narrative of higher inflation and higher rates [as well as more US strength] – this makes fixed-income/bonds less desirable as you don’t benefit off the bond appreciation associated with dropping interest rates. Consistent interest rate levels and increasing interest rates are a positive for cash over bonds and vice versa. We are watching out for a change in outlook here as that should impact cash, bond and equity mix capital flows.
Private Markets
A significant trend that is taking capital flow that is worth keeping an eye on is the move to private market investments - innovative structures have opened what is being called the ‘private wealth’ channel. Family offices have roughly 50% of their portfolio in private markets. Now, we are seeing private wealth move into the private markets for reasons including higher expected returns, lower expected losses and diversification away from the traditional asset classes given the fragility of the markets.
Aug 5th – how did your portfolio fair? There’s an expression that says if your portfolio is diversified, someone like me is always having to say sorry to you because some parts of your portfolio will always be down. If everything was moving in the same direction, then your portfolio is not diversified. That isn’t noticed about 80% - 85% of the time, when public equities are up, but it comes as a stark reminder when conditions change, and they change quickly in today’s fragile market.
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Warning: This is a marketing communication. This document is not a contractually binding document and has been prepared for information purposes only. It is not intended as and does not constitute a personal recommendation. Please do not base any final investment decision on this.