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We are not quite at the end of January, and yet already equity markets have blown past most commentators’ year end targets, and some illustrious investment banks have been stopped out (at a loss) of some of their top trades for the year.  What has gone so right/wrong?

Well, the first point to make is that this level of forecasting, to specific dates, or where trades have binary outcomes, is incredibly difficult (if not impossible) to get right, and certainly on any kind of consistent basis. This is not to say that markets will not roll over dramatically, tomorrow, next week, or next month; or to suggest where they may end the year.  But that is the point, no one knows, and it can be expensive to set your portfolio up as though you do.

In this particular instance, in the latter stages of 2011 you couldn’t find anyone with a good word to say about market prospects for 2012, which almost by definition sets up the prospects of a rally, however short.  Our own proprietary indicator, based on a weighted mix of macro and technical data, remains at a low level but bottomed in late September 2011, and has been steadily rising ever since, which supported, for us, any subsequent rally in risk assets.

Our view is that one can avoid some of the pitfalls of market timing and “decimal point forecasting” – both of which have truly hideous track records – by maintaining properly diversified multi asset class portfolios.  In this instance one can create an “all-terrain” vehicle, the core of which can ride through choppy market conditions, without the need to panic in or out of the market, or for an exact forecast to come true.  Investors then get a better night’s sleep, and are less likely to feel the urge to “do something/anything”, which often results in investing in the “rear-view mirror”, and creating a portfolio that would have performed well in the previous months, except that of course one didn’t have it back then.

The multi asset class investor will, however, want to also avoid the pitfalls of so-called “di-worsification”, and to this end one does indeed need to take some views on market valuation, investor sentiment and so on.  However this involves simply trading at the fringes of the core portfolio, to continue baking longer-term value into the cake, and taking advantage of any opportunities that current market conditions may present.  This would also include sensible house-keeping such as profit taking and portfolio rebalancing, which maintains the appropriate risk level of the overall portfolio, and banks some realised gains.

In summary, it is best to avoid investing with a low probability of success, and therefore marketing timing and binary trades are best left to those who can afford to lose the money.  It is entirely possible to create portfolios “for all seasons”, which remain fully invested across a range of assets, and keep an eye on the goal of longer term capital appreciation.  There will always be opportunities to tilt the portfolio at the margin, and without catastrophe if you are “wrong”, as inevitably you will be from time to time.  The successful investor is never foot perfect, but is one who gets slightly more decisions right than wrong, in more circumstances, and has not risked too much downside to the decisions that don’t pan out.