Predictably Unpredictable

By Eric Burkholder, Portfolio Manager

A 2012 review of market outcomes and the “experts” who failed to predict them.

“Prediction is very difficult, especially if it’s about the future.” – Niels Bohr, Danish physicist

The world of investment advice and market forecasting is very profitable.  Let me rephrase that.  The world of investment advice and market forecasting is very profitable for those selling the advice.  The outcome for those who invest on said advice is not quite as rosy.  So each year I make a point to track all the “expert” predictions and highlight some of the more pronounced failures.  2012, as expected, did not disappoint.

“Dry Powder”

Coming off the sour end to 2011, experts pulled back the reins on their forecasts for 2012.  On the optimistic side analysts predicted an average gain of 6% for the S&P 500.  Probably a welcome prediction for investors somewhat shell shocked by the previous year’s volatility.  Many experts learned their lesson from their overly optimistic predictions from last year and would not be fooled again.  The catch phrase for 2012 was “Dry Powder.”  Many managers were keeping their clients’ money in cash until things “cleared up”.  A survey of 260 asset managers across the globe found that they had increased their cash levels to the highest allocation since the height of the financial crisis in 2009.  Barclays’ investment managers were allocating up to 45% of their lower risk clients into cash.[1]  Hedge Fund managers, presumably the smartest guys in the room, even held substantial allocations to cash during 2012.

If your manager held cash in your portfolio or you invested based on the collective wisdom of Hedge Fund managers your portfolio statement for 2012 may feel a little “light”.  Just about every equity market across the globe performed very well.  The Russell 3000 (a broad measure of the US market) returned 16.42% for the year and the MSCI World Index (a broad measure of the international market) was even more impressive with a return of 20%.  Virtually every asset class enjoyed healthy positive returns for 2012; except of course cash which gave 0% and hedge funds which returned a measly 3.5% for the year.[2]

“Dr. Doom”

There is a saying that even a broken clock is right twice a day.  This also applies to most market forecasters.  Famed economist Nouriel Roubini, or Dr. Doom, famously “predicted” the 2008 financial meltdown.  He also predicted meltdowns in 2007, 2009, 2010, 2011, and, you guessed it, 2012.  Many forecasters have become wise to putting specific time frames on their predictions (Google: “Meredith Whitney Muni Bond Prediction”).  But Roubini has given some specific estimates this year.  Notably he predicted that the US growth would stall in 2012 and 3Q GDP may come in “well below 1%”[3]  The revised 3Q GDP came in substantially higher at 3.1%.  He is now predicting a global crisis to happen sometime in 2013, but if not 2013 then for sure by 2014…or 2015.

Roubini was not alone in casting a dire forecast for 2012. At the start of the year Morgan Stanley’s Chief U.S. Equity Strategist, Adam Parker, put a price target on the S&P 500 of 1,167.  That price would have represented a return of minus 10% for the year.[4]  He then doubled down on his bearish prediction in September and predicted the S&P would end the year at 1,214.  This represented a 15% pullback from the price in September.  The S&P 500 ended the year at 1,426; an increase of just over 13% for the year.

“Death of Equities”

If the phrase “death of equities” sounds familiar that is because it comes from one of the most famous BusinessWeekcovers ever printed.  It was the year 1979 and the magazine boldly proclaimed equity investing was dead.  Within months of its printing the stock market went on one of the longest and highest returning bull markets of all time giving investors nearly 20% returns annually.

It turned out to be one of the worst market calls ever and that is exactly the reason Bill Gross raised so many heads this year when he pronounced “the cult of equity is dying.”  Bill Gross is the co-founder of PIMCO, the largest actively managed bond company in the world.  It should be evident that he stands to gain substantially if more people choose bonds over equities; nevertheless, he is an extremely successful bond investor and many people think we should heed his warnings.

While we will not know the accuracy of his forecasts for many years to come, it might be helpful to remember what he said in 2009.  Mirroring his latest prediction, he suggested higher bond allocations and less exposure to risky assets like stocks was the smartest thing to do going forward.[5]  Since 2009 the S&P 500 has given a total return of 101%.

Many people might argue that some people in fact did predict a good 2012 and I selectively picked on the losers.  I have no doubt some got it right, but that misses the point.  The point is that this year’s winners will be next year’s losers.  And just like a real casino, if you play the game long enough you lose all your chips.  A globally diversified, low cost portfolio does not require predicting the future and is still the only proven way to build long lasting wealth.  If you don’t have to gamble your future to make it to retirement why would you choose to?

So when your advisor tells you of the next great mutual fund or what the markets will do next year just ask yourself:  “If the best money managers and economists in the world seem to get it wrong so often what makes my advisor thinks he can do it?”  And more importantly “How much is it going to cost me when he is wrong?”  






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