Why are stock market ‘experts’ reluctant to accept uncertainty?

Now, the idea behind such statements is primarily to establish that investing in stocks earns a superior rate of return in comparison with other asset classes. From April 1979 to October 2024, the Sensex has given a return of 15.2% per year.

Add a dividend yield of 1-1.5%, and we are looking at a rate of return of slightly less than 17% per year, largely in line with what the stock market experts talk about.

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Of course, it can be argued that the Sensex fell sharply in October and hence the returns are slightly lower. From April 1979 to 26 September 2024 when the Sensex peaked, the annual return worked out to around 15.5% per year. With a dividend yield of 1.5%, we arrive at a return of 17% per year.

There are two major problems with this argument. First, it does not tell us that a bulk of these returns were made before 1992, when most of us investing in the stock market right now were either not around or were not old enough to be buying stocks.

So, how do things look if we adjust for this deficiency? We need to consider the returns delivered by the NSE 500 Total Returns Index (TRI), which takes the dividend yields of stocks into account while calculating returns. Also, this index is much broader than the Sensex and is thus a better representation of the stock market.

Further, it has data from January 1995, allowing us to ignore the tumultuous period of 1992 when Harshad Mehta drove up stock prices through various financial shenanigans. It also allows us to ignore 1994, when many promoters launched initial public offerings (IPOs), collected money and disappeared.

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The NSE 500 TRI has delivered a return of 12.7% per year from January 1995 to October 2024, which is pretty good, but nowhere as good as 17-18% per year as claimed by the experts. An investment that earns a return of 12.7% per year will double money in a little under 5 years and 10 months, which is a reasonably good proposition.

The second problem with the argument of stocks delivering an annual return of 17-18% is the way this story is sold: It is as if there is a certain predictability to these returns, which is really not the case.

As Pulak Prasad writes in What I Learned About Investing From Darwin: “Investing would be easy if companies could compound predictably. But, alas, they don’t. The real world is quite messy, and the path to long-term success is treacherous, unpredictable, and full of disappointments."

The larger point here is that ‘when’ you end up buying stocks also matters. If you had invested in early January 2008, when the stock market had reached its then peak, your returns up until October end would have averaged 10% per year, as per the NSE 500 TRI.

Or if you had invested in a stock like Infosys when it reached astonishing valuation levels in the early 2000, you would have barely made any return over the subsequent few years. Or if you had invested in Sensex stocks in September 1994, when the index reached its then peak, you would have earned a return of around 9.9% per year until 31 October.

On the flip side, if you had entered the market at its covid-led bottom in March 2020, you would have earned a return of 33.7% per year.

So, stock markets are really not anywhere as predictable as they are made out to be.

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Indeed, this kind of predictability is also sought to be conveyed by the ‘buy’ ratings that analysts give for stocks, together with the exact prices they’re expected to reach, instead of a range. Or when experts make predictions about the stock market reaching a precise level at the end of the year, at the end of next year, and so on.

Or when analysts use valuation models with dodgy math to create the veneer of a rationale to justify the fancy valuation being asked for by a company selling shares to the public through an IPO, even though it does not make any money yet and really hasn’t got much of a business model.

It seems like professionals working in the stocks business have an uneasy relationship with uncertainty, which is why they are perpetually looking to provide crisp, confident and definitive answers to complex questions, so that they can shut down any debate.

As the French philosopher Voltaire put it a few centuries back: “Doubt is not a pleasant condition, but certainty is an absurd one."

Finally, as Philipp Carlsson-Szlezak and Paul Swartz write in Shocks, Crises and False Alarms: How to Asses True Macroeconomic Risk, the rigour of natural science is ascribed to economics, “suggesting that certainty is a reasonable proposition because we can follow the science."

Further: “But the reality remains that economics is too uncertain, too non-stationary and too multidisciplinary to pass as a natural science." Now, what’s true about economics is also true about investing. Which is why stock market professionals need to have a more mature relationship with the uncertainty at the heart of their business. But their incentives are so set up that they choose to do otherwise.