Never believe in predictions when it comes to investing.

1. What you need to do is not predict, but assess the risk.

For humans, the world is unpredictable, mainly because the future is unpredictable.

We live in a complex, interconnected world where no one can know for sure what will happen next.

Looking back at recent major events in the market, any real evaluation would acknowledge that they are unpredictable.

No one intentionally predicted the outbreak of the COVID-19 pandemic, and we don't know where it came from. In fact, looking back, we still haven't fully determined its origin.

The subsequent astonishing bull market also seems unpredictable, with a crazy bull market appearing in the stock market after global lockdown, which is unprecedented.

Other market-driving factors are not naturally occurring "black swans" (like COVID-19), but depend on the decisions of a small group of people, and these decisions can have any driving effect.

While you cannot predict an epidemic, when you carefully assess the risks, you can estimate the likelihood of such situations occurring, even if you don't know the exact timing or manner of their occurrence.

However, these are all risk assessments, not predictions. Because you understand that stock prices will be affected by broad and unpredictable events, you need to ensure that you do not increase leverage, and you also know that a 50% decline is possible.

If you trust the predictions you or others have made about your investment portfolio, then you are taking a risk with your own funds.

Therefore, when we were planning our column content for 2022, we switched to doing risk assessments (rather than predictions) to determine how to create a well-balanced and risk-resistant investment portfolio.

We will try to understand all potential events that may occur and find potential returns without taking excessive risks.

2. Solution for predictions: Turning complex predictions into simple forecasts.

As investors, we prefer to understand companies and decide which stocks we want to hold in the long term. This is much easier than macro-level operations.

If you can buy at a reasonable price and hold for a period of time, you can accumulate real wealth.

We also use an investment portfolio method that allows you to invest based on developmental potential rather than predictions.

For example, we have placed bets on Bitcoin (BTC-USD) with high returns (achieving a growth rate of 331%) in our simulated investment portfolio, as well as software service stocks such as Asana (ASAN) and Sea Limited (SE) which have increased by 183% and 407% respectively.

In the past few months, the returns on all of these investments have been poor, and we must admit that we did not anticipate this. But the long-term returns of holding them are substantial, and we are willing to withstand this volatility to wait for the returns they bring.

We can hold a small position and earn big returns over time, even if we cannot accurately predict the trend every month.

You need to have a benchmark for future expectations, which is more helpful to you than complex predictions. Instead of predicting whether the economy will be constructive or if valuation will increase, simple outlook can prevent you from being overly confident, without any other reasons.

Taking this into account, now we can look at an indicator to form the perspective of this article.

3. A method to form a benchmark: Look at the yield curve.

We are optimistic and will continue to invest in the stock market. But we do see that the yield curve, hidden beneath the surface, reveals to us the reason to be cautious about bonds.

The yield curve is the difference between short-term and long-term bond rates.

When the yield spread "inverts", that is, when short-term bond rates are higher than long-term bond rates, it is a strong indicator that a recession is imminent, and this news becomes the headline of financial media.

But at other times, the yield curve is only of interest in the bond market, although it still reveals a lot of information.

Now the yield curve is flattening, which is not a good sign.

If you plot the interest rates of each maturity bond on a curve, this curve usually has a slope. Under normal circumstances, considering the lock-up period of capital and greater uncertainty in the future, bond investors would demand a higher yield for 10-year bonds than for 2-year bonds.

This was indeed the case at the beginning of 2021, but now this curve is flattening, as shown in the chart below, and the curve in March last year was steeper than it is now.

Alternatively, you can also look at the difference in interest rates between 2-year and 10-year government bonds from a different perspective, which shows that the yield curve has recently been declining rapidly.

Overall, the yield curve has not inverted, but it is flattening.

The bottom half of the chart shows the interest rates of 10-year and 2-year government bonds respectively. We can see that the yield curve has flattened, but this is only because short-term interest rates have risen (rather than long-term interest rates declining).

This is called a 'bear flattener', indicating that inflation will continue, so long-term bonds are not attracting attention, indicating that the Fed will raise interest rates, causing short-term rates to rise.

Neither of these two outcomes is good for bond holders.

However, research data from Merrill Lynch, an investment management company, from 1976 to 2018, shows that this will be bullish for the stock market.

During the bear flattener period, the stock market's annual return rate was 17.4%, compared to an average annual return rate of only 12.4% over the entire research period. This reflects the phenomenon of stock prices continuing to rise due to lack of other investment-worthy sectors. This is also why we hold fewer fixed income positions in the 'complete, income, and defensive' investment portfolio.

This year, we will continue to focus on the benchmarks we expect to have a strong economy, but we also need to understand that valuations are very high. Subsequently, we will carefully balance your wealth based on dozens of potential evaluations, risks, and opportunities.

While we strive to outperform the market, a well-diversified investment portfolio can protect your wealth through position sizing and diversification, which a simple stock philosophy cannot achieve.

The key here is to understand that you do not need to predict how the market will operate, you just need to avoid mistakes and bet on different outlooks with the right combination.

For your health, wealth, and retirement life, please invest correctly.

Analyst: Dr. David Eifrig

Compiled by: Samantha