The Market Doesn’t Need Our Prediction
The Federal Reserve raised the federal funds rate by 0.25% this week. But something interesting happened before the Fed made its announcement: the market had already begun adjusting.
As Wes Crill of Dimensional points out, as recently as May, futures markets placed almost no probability on a September rate increase. Then new inflation data arrived. Expectations changed quickly, and the one-year Treasury yield moved higher by roughly the same magnitude as the Fed’s eventual increase—before the Fed actually raised rates.
That’s an important lesson for investors.
Markets look forward.
And that isn't unique to interest rates or bonds. Stock prices, bond yields, currencies, and other market prices are continuously being established by millions of buyers and sellers incorporating what they collectively know—and what they expect may happen next.
That means our job as investors isn't to correctly predict the Fed’s next move, next quarter’s earnings, the economy, inflation, or where markets are headed.
In fact, consistently predicting those things before everyone else—and then successfully turning those predictions into better investment results—is extraordinarily difficult.
There is freedom in understanding that.
The market doesn't need to know what I think it's going to do.
Prices will continue adjusting as new information arrives, whether our predictions are right, wrong, or somewhere in between. Rather than trying to outguess that process, we can participate in it.
This is one of the principles underlying Dimensional’s investment approach: begin with financial science, use market prices rather than predictions, and pursue the dimensions of expected returns identified through decades of academic research.
History continually gives us opportunities to see these principles at work.
This week's Fed announcement gave us another one.
Source and inspiration: Wes Crill, PhD, Senior Client Solutions Director and Vice President, Dimensional Fund Advisors, “The Market’s Fed Watch in Action.”