One of the key facts repeated by the investment industry (although I’m sure some people selling mutual funds say it under their breath) is that past performance doesn’t predict future results. Although there are some time periods that are a bit more predictable, there’s uncertainty at every level from the random day-to-day variations to the long-term trends shaped by the current environment. The reasons vary at different time scales – recently I came across a new reason for long-term uncertainty.

Clearly short-term moves in the next 1-2 years can easily go in any direction. In the 7-10 year range it’s a bit easier to form a guess on what’s likely to happen, but the end result will still be unpredictable. Over 20-100 years people generally expect significant economic growth.

The recent “A Night With The Bears” event highlighted one speaker described his theory about “long waves”, or economic cycles that are about 60 years long. According to this, we would be at the start of a long decline or stagnation. Although there does seem to be more predictability in longer time periods and nothing is immune from cyclical effects, the idea that we’re reliving the past isn’t right either. 

One of the obvious reasons is one-time events. Many people speak of the “post-war” economy that’s developed in North America and Europe in the last 60 years. That particular course of events was most likely heavily influenced by the Great Depression and World War 2, so we’re already on a different course. That’s not the only reason things will turn out differently – there are also fundamental changes in the nature of the markets.

While reading Geroge Soros’ book The Crisis of Global Capitalism, I noticed that one of the points he brings up repeatedly is how the market eceonomy has changed significantly since 1980. I already knew that the last 20-25 years have been an unusual and very long bull market for stocks, which had to result in either a decline or a reduction in future returns since stocks were growing at an unsustainable rate. Add this to some historical studies that show a long-term real return of around 6% from stocks and you can guesss the specific adjustments.

However with the new information from this book it seems that the bull run may have simple explanations, rather than being a random variation that has to return to the mean. According to Soros, the policies of Regan and Thatcher in the early 80s played a big role in opening up markets to free competition and innovation with less regulation. This change may have been a major factor in the rise in stock prices and the eventual speculation and instability.

Although it doesn’t explain everything, being able to put the recent bull market into context has interesting implications. It’s also a great demonstration of why it’s difficult to predict the future. Everyone knows that over the centuries the dominant countries, empires, and cultures change drastically. But there can also be big shifts in a times as short as a decade or two. The specific changes are different each time, making the future highly uncertain.

Current events could result in more regulations and lower returns for some time before market participants figure out the best thing to do in light of recent lessons. Or quick fixes could encourage people to restart an unsustainable bull market, taking stock prices even higher before a change is forced on them. What’s most worrying is that there’s still a possiblity that people as a whole will forget common sense and lessons from the past and take a big step back to policies that restrict economic growth for a long period.

The long-run trend in stock prices may not be affected much when the last 20 years are combined with the next 20, but that’s still a historical fact rather than a fundemental law. In The Black Swan, Nassim Taleb mentions that if you look at a stock chart with the dates removed it’s hard to tell whether it’s for one day or 5 years (you can even turn it upside-down and get the same effect). This illustrates how unpredictable markets are on different levels but if you want to understand what’s actually going on and possibly profit from it you need to know the different reasons.

In the long-term we can make predictions about where current pressures will drive the markets, but we have to remember that the markets we’re talking about are always changing. Trying to predict the future based on the past at any level is likely to be a losing game because the conditions and participants are always changing. Understanding the past is a great way to keep up with future developments though.