Forecasting the Year Ahead, and Preparing to Be Wrong
By PAUL SULLIVAN
Published: December 27, 2013
THIS is the time of year when investment analysts predict what they believe will happen over the next 12 months. That they are invariably wrong about something is a given. Or, to be more charitable, it is a given that events that no one could have foreseen will have caused their deeply researched predictions to be incorrect.
John Marshall Mantel for The New York Times
Mike Ryan, a strategist at UBS Wealth Management Americas, said something — he can’t say what — was bound to go wrong.
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Barbara Reinhard, of Credit Suisse, expects a brighter growth picture in 2014.
Consider the sustained increase in United States stock prices this year. Many predicted that the Standard & Poor’s 500-stock index would have a good year, but no one predicted it would rise 29 percent.
And already one prediction that every strategist I talked to made for next year is wrong: that the Federal Reserve would curb its bond-buying program in March or later, if the economy remained weak.
On Dec. 18, the Fed announced that it would buy $10 billion less in bonds a month starting in January.
After the announcement, Gary Thayer, chief macro strategist at Wells Fargo, pointed out in a note to clients that the unemployment rate at 7 percent was about one percentage point lower than when the Fed started this round of bond-buying.
Clearly, he and some of the other strategists who watch these things did not think a 7 percent unemployment rate was all that good, but the Fed disagreed.
It’s easy to pick on strategists for what turn out to be miscalculations, but it’s not terribly productive. If clients did not want one-year predictions, Wall Street would probably stop providing them. And the timing, in the case of tapering, may not matter since it signaled that the economy is doing better.
So this year I wanted to do something more than just look at the year ahead and argue the pros and cons of various predictions. After asking what people were predicting, I wanted to know why we still bother with these predictions. If the last decade has taught us anything, it is that unexpected events can knock our portfolios for a loop.
Next week, I’ll look at views on what is likely to happen during the next three to five years and ask why there has not been more of a push for longer predictions.
Up first, the year-ahead game.
CONSENSUS VIEWS The United States stock market has had a remarkable run this year, and the view is that it will continue. But unlike this year, that rise is likely to be more uneven.
Barbara Reinhard, chief investment officer for the Americas at Credit Suisse, said: “Global growth is going to be better in 2014 than 2013.”
In the United States, she said, the drag of the sequester cuts would disappear, and Europe was expected to move into modest growth. Stocks, on a historical basis, are not expensive, and investors have been slow to put money back into equities, so there is reason to think they could continue to go higher.
“This doesn’t mean we aren’t in for some sort of pullback,” she said. “We should experience a 5 to 7 percent pullback at some point.”
Katherine Nixon, chief investment officer at Northern Trust, said an anomaly of this year’s rally was the lack of large dips compared with previous years.
“Investors haven’t experienced a truly volatile market in quite some time,” she said. “Volatility is normal, but we’re riding below normal. So to get us back to normal may feel like a real increase in volatility to people.”
Her concern is that when normal volatility returns in the United States, investors could get spooked.
Next year is also predicted to be one in which Europe may begin to do better, and that means European companies, beyond financial institutions that rebounded broadly this year, are expected to do well.
Ms. Reinhard said her favorite countries were Germany and the peripheral countries that were hit hardest by the recession but have since engaged in structural reforms: Ireland, Italy, Spain and Greece. “Europe is one of our favorite regions in 2014,” she said. “We like it over the U.S.”
Dean Tenerelli, European stock fund manager for T. Rowe Price, said that anyone looking to invest in European companies should have at least a two-year time horizon to weather possible volatility. “Even if things are looking more positive, we’ll still have 1 to 1.5 percent G.D.P. growth in 2014,” he said. “There is still a long way to go before our companies recover to normalized earnings. It’s possible we have a correction next year.”
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AREAS OF CONCERN Bonds are one area of concern. Since interest rates on fixed income, particularly benchmarks like 10-year United States Treasury notes, fell so much over the last few years, the view is they will begin to rise as the Fed ends its bond-buying program and the economy improves. As that happens, the value of bonds that people already own decreases.
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Paul Sullivan writes about strategies that the wealthy use to manage their money and their overall well-being.
Expecting such a situation, the prevailing wisdom is not to buy bonds or to buy bonds with shorter maturities, say under five years, which will lose less of their value. But thinking in binary terms like this has risks.
“We either love or hate an asset class and go all in or all out,” said Mike Ryan, chief investment strategist at UBS Wealth Management Americas. “I don’t know what is going to go wrong in 2014, but I know something will. Every allocation has to take into account that there will be stresses, and bonds are a counterweight to that.”
Municipal bonds are their own area of worry. Hugh McGuirk, vice president and head of municipal bonds at T. Rowe Price, said the market this year was down about 2.5 percent and he did not have high expectations for a positive return in 2014. “The best-case scenario for municipal bonds is the economy doesn’t grow like people think and the effects of coming out of the recession peter out and maybe rates don’t move at all,” he said.
In that instance — which would be awful for anyone who was not a municipal bond investor — he foresaw returns from a positive 3 to 4 percent to a negative 2 to 3 percent. If there is an upside, he said it would be in municipal bonds tied to essential services like water and sewer rates. The general obligation bonds, once seen as the safest to own because municipalities could just increase taxes to make their payments, have been tarnished by financial crises in Puerto Rico, Detroit and Illinois.
Then there is China, which is a special case since it is causing worry for 2014 and also for the next three to five years. The fundamental question is what will happen to companies and countries that have depended on China for trade as the country tries to move its economy away from being export-based. One fear is that commodity producers and exporters will be hit hard by China’s changes.
WHY PREDICT? Whatever its value, the one-year prediction, Mr. Ryan said, is ingrained in who we are as people. “We account for our life in four seasons,” he said. “What did farmers focus on in the summer? What the fall crop was going to be. What did they focus on in the winter? How much rain they were going to get in the spring. We talk and think in temporal terms. The year ahead — it’s always reinforced.”
Ms. Reinhard, however, sees real value in predicting what will happen next year if people are looking at the right indicators. She said looking at gross domestic product, for example, was not forward-looking in the way that analyzing manufacturing orders was.
Her stock market number for the S.&P. 500 this year had been 1,750, or a 20 percent increase from where it closed in 2012. It was at 1,841.40 on Friday. For next year, she put that number at 1,960, which would only be a 6.4 percent increase from Friday’s close.
Others find the exercise of one-year predictions a waste of time. “Nine out of 10 times when I’m asked what will happen next year, I say stocks will tend to perform along the historical average, which is 10 to 12 percent a year,” said John Buckingham, chief investment officer of Afam Capital and editor of the Prudent Speculator newsletter. “Have I ever been right? No. I don’t care what the market will do. I had an expectation of 12 percent at the beginning of the year, and I was wrong. But I’m up 30 some percent in my portfolios and I’ll take that.”
He added that revising predictions during the year could be equally perilous: “The best time to get out of equities this year was August. We had Syria, the Fed talking about tapering, a government shutdown and September and October are generally bad months. What happened? We were up 4 percent each month.”
But his biggest worry was the predictions he had seen for another 20 percent increase in stock prices. “I’d rather have a contrarian view,” he said.
Of course, that is still a prediction, even if it goes against the grain.
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