Predicting The Long-Term is Easier Than Predicting The Short-Term

14 November 2016 | by Sean Stannard-Stockton, CFA

One of the more counterintuitive things about forecasting the future is that long-term trends are generally easier than short-term trends to predict. The idea that it is easier to predict what will happen over the next five years than it is to predict what will happen next quarter is a key reason why long-term investing works better than short-term trading.

One concrete example of this dynamic at work is the fact that we all know that a forecast about the weather on this coming December 4th is just a guess, but we certainly feel comfortable with the idea that we can reliably predict what the average temperature will be in December 2020. This post from Nate Silver’s 538 discusses this phenomenon and shows how our ability to predict the weather in the short-term only extends out 3 to 5 days, while at the same time we have the ability to make accurate forecasts about global weather patterns that stretch years into the future.

Similarly, investors have no ability to predict what the market will do the next day or even the next year, but we can make reliable forecasts about what they market will do over the next couple of decades. Ben Carlson explored this concept earlier this year where he showed that rolling 30-year returns for the stock market have averaged about 11% a year with a standard deviation of just 5%. The worst 30-year return was just south of 8% a year for the 30-year period beginning at the top of the 1929 stock market bubble before the Great Depression. The best was a little less than 15%. The last 30-years have seen annual returns of just shy of 10%.


Source: A Wealth of Common Sense

Sidenote: keep those long-term returns in mind when you hear people say that you should plan on low stock market returns in the future. Anyone suggesting that the stock market will return less than 8% a year over the next 30-years is actually saying that we’re in for the worst market of all time, worse than the 30-year periods that included World War II, the Great Depression, the Financial Crisis, the Dot Com Crash and the hyper-inflation of the 1970s.

But what about next year? Or even what about tomorrow? Investors have demonstrated zero ability to predict what the market will do in the short-term. For a real-time case study, see the unexpected market impact of the US presidential election results. The market could be up 30% in 2017 or down 30%. Or more in either direction. Or flat. It is impossible to say. But while long-term trends still have significant variability and investors must realize that just about anything can happen in the future, many long-term trends have a far more narrow range of likely outcomes than do short-term trends.

The average mutual fund holds a stock for about a year before selling. That means that their decision-making process is focusing on short term (unpredictable) metrics. These sorts of investors/traders might call themselves long-term investors, ape the slogans of Warren Buffett and discuss their valuation discipline, but really they are just trying to guess how many iPhones Apple will sell this quarter, what the price of oil will be next quarter or, in the longest time frame, what hospital spending might be next year in light of potential changes to ObamaCare.

Long-term investing shouldn’t mean that you hold stocks for many years no matter what. It means that you make decisions based on long-term outlooks. How many iPhones can Apple sell over the next five years? What oil price is required over the next 10 years to stimulate enough oil production to meet demand? How will health care spending trend over the next two decades as our country grapples with how to restrain the #1 driver of Federal debt?

The reason focusing on these long-term trends is the right way to approach investing is not because long-term investing is somehow morally superior to short-term trading (we like to make money quickly rather than slowly, all else equal), but because these long-term trends are far more predictable than short-term trends.

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