Personal Notes

New Year’s Day – incredibly warm weather. I would have not guessed the temperature would be warm enough to play golf. It was, and I did. Imagine that – golf on January 1st in the Lehigh Valley. Perhaps, this is a start of an annual event – the Champagne Open!

Beware of Those Economic Forecasts and Financial Predictions for 2012

They are frequently wrong. And, being well known and quoted on CNBC or in some other media does not matter. Highly improbable things happen all too frequently; and, they have deep and unpredictable impact on our world.

For some examples of incorrect forecasts and predictions I accumulated for a past Weekly Commentary, see below:

1. ONWARD AND UPWARD – The S&P 500 was up +9.2% YTD (total return) through Friday 7/20/07, closing at 1534. The headline in Barron’s over that weekend stated “It’s Still Time to Buy” forecasting an additional +6% rise to 1625 by 12/31/07. Instead the stock index fell 4.3% to finish 2007 at 1468 and a whopping 37% in 2008 (source: Barron’s).

2. STRONG FINISH? – As of Labor Day in 2007 (9/03/07), there were just 4 months remaining in the calendar year. The S&P 500 had closed the previous week at 1474. Barron’s asked 8 equity strategists to predict where the S&P 500 would finish the calendar year 2007. 7 of the 8 saw a rising stock market by year-end with one prognosticator foreseeing a 12/31/07 value of 1700 (source: Barron’s).

3. FALLING – In January 2007, the S&P 500 companies anticipated 2007 earnings growth of +9.4% from a year earlier. The actual equaled a 4% decline (source: S&P, FT).

4. CLUELESS – At the close of business on Wednesday 10/09/02, the S&P 500 bottomed at 777 before beginning a bull market run that gained +101% to peak at 1565 on 10/09/07, exactly 5 years to the day after the bear market bottom. The headline in the business section of USA Today on Thursday morning 10/10/02 was “Where’s the Bottom, No End in Sight” (source: USA Today).

5. STOCK MARKET CRASH TRIVIA – On the morning of 10/19/87, the trading day that ultimately resulted in the largest 1-day percentage loss in the history of the S&P 500, the WSJ ran a front-page article with the subtitle “Some Stay Bullish, Believing Downturn is Temporary.” The S&P 500 fell 20.5% that day (source: WSJ).

6. THE DEAD RISE – On 8/13/79, Business Week ran a cover story that was titled “The Death of Equities.” The S&P 500 closed at 107 on 8/13/79. The S&P 500 closed calendar year 2007 at 1468 (source: Business Week).

7. NO CHANGE – The USA Today Economist of the Year for 2006 (Richard DeKaser) predicted on 3/20/07 that the US Fed would keep interest rates unchanged throughout 2007, leaving them at 5.25%. Instead the Fed lowered rates by 4 times (source: USA Today).

8. THEY MISSED AGAIN – The average prediction made on 1/01/07 by 58 Wall Street forecasters for the yield on the 10-year Treasury note as of year-end 2007 was 4.88%, an increase of +0.17% over its 4.71% level from 12/31/06. Instead the actual 12/31/07 yield did not rise from a year earlier but fell to 4.02% (source: Business Week).

9. THE HERD – 82% of money managers believed in late December 2006 (and again in December , 2010) that long-term interest rates in the US would be “unchanged or higher 12 months later.” The yield on the 30-year Treasury bond was not “flat to higher” but rather declined from 4.81% to 4.45% during calendar year 2007 (source: Merrill Lynch).

10. IT DIDN’T DROP – 56 economists that were surveyed in mid-January 2007 predicted that the average price of oil would be $58 a barrel in the 4th quarter 2007, down $3 a barrel from its $61.05 price of 12/31/06. However the price of oil did not fall but rather rose +57% during 2007, closing last year at $95.98 a barrel (source: USA Today).

The Markets This Week

So that was the 2011 stock market, a nerve-rending trip to nowhere.

Defying both statistical probabilities and the amplitude of the emotional swings the tape induced, the Standard & Poor’s 500 finished the year within a whisper of its start point, closing Friday at 1257.60, versus 1257.64 a year ago. To emphasize the point-to-point stasis of U.S. equities, the equal-weighted version of the S&P 500, best tracked via the Rydex S&P 500 Equal-Weight exchange-traded fund (ticker: RSP), closed 2010 at 46.59; it finished Friday at 46.29.

In standing still, the market spent the year doing the financial equivalent of a driver “feathering the clutch” in a car sitting midway up a steep incline: The direction of nature’s pull was lower, but just enough force on the gas pedal now and then, with the exact right simultaneous pressure on the clutch, halted the backsliding and kept things steady, if precariously so.

The force of gravity, in this instance, was the macro/Euro/credit drama, constantly keeping investors on alert for some force majeure declaration that the financial system itself—banks, currencies, international trade arrangements—was again in peril. The fuel opposing it was corporate business conditions, with rising profits and plenty of cash on companies’ books.

Part, but not nearly all, of last year’s erratic daily pattern can be explained by the flight of patient capital from equities, leaving the field to the short-term scalpers and incentive-fee mercenaries who must trade to survive. According to fund-flow research firm EPFR Global, a net $75 billion departed U.S.-focused stock funds, a majority of the $123 billion that left developed-market funds. Another $47 billion on a net basis flowed out of emerging-market equity funds.

This is probably bullish for future multi-year equity returns, but says nothing about the next several months or even all of 2012. Just because an asset class has been orphaned doesn’t mean it’s about to be adopted by some other benevolent souls.

THE S&P 500 HAS RARELY FINISHED a calendar year very close to where it began. John Harris, a market historian and author, notes that since 1928, the S&P 500’s total return in a given year has been between minus 5% and plus 5% only nine prior times, first in 1934 and most recently in 2005. He worked up some numbers about the performance of each subsequent year. The net result is a positive tendency, but sometimes with some nastiness in between.

The average S&P 500 return in years following those nine previous flattish years was 26.3%. Yet three of those years—1935, 1940 and 1982—held either a bear market or severe correction in store before things improved, with losses ranging from 15.2% to 28% at the year’s low.

This nicely captures the present, with a pat bullish case based on a firming domestic economy, strong (for now) corporate fundamentals and aggressive money-printing countered by an uncomfortably high chance of credit meltdown and no clear path out of a developed world swimming in debt.

Brokerage-firm strategists are again putting out targets for an 8% one-year market gain, to 1360 on the S&P 500, basically last year’s high. They practice the “art of the plausible,” and such a target is that, assuming profits continue to grind higher and Europe declines its many invitations to implode.

The central-bank financing scheme put in place weeks ago in Europe was widely panned but truly could buy the banks and governments quite a bit of time, or at least stave off the sort of disorderly liquidation attack that investors are fearing. We need to see the markets operate free of the year-end pressures to shrink balance sheets, sell assets and trim risk to determine whether this is a valid working assumption. The U.S. housing market likely has bottomed and we could be one announcement away from a blowout jobs report.

Yet, there’s a nagging, if rarely addressed concern: time. A year ago, there were signs (not embraced by many, but detailed in Barron’s) that we could be in for a rerun of the 2005 market, in which prior bull-market gains were digested in range-y trading, with price/earnings multiples declining.

This happened in 2011. But the next act of this bullish production, following the example of 2006, would involve the “financial engineering” stage of a bull market, with buyouts and a leverage binge taking over from rebounding corporate profits. If the Euro-fix is seen to be in, risk appetites would surge and volatility would drop to accommodate such a scenario, but that’s an “if” too big for most to bet on. The clock is also ticking on corporate profit margins, now at a record high. The market rarely puts a fatter multiple on very high margins (Source: Barrons Online).

The Numbers

Last week, Bonds and Foreign Stocks increased while U.S. Stocks decreased. During the last 12 months, BONDS outperformed STOCKS.



































Returns through 12-30-2011


1-week


Y-T-D


1-Year


3-Years


5-Years


10-Years


Bonds- BarCap  Aggregate Index


     .7


     7.8


7.8


   6.8


   6.5


    5.8


US Stocks-Standard & Poor’s 500


    -.6


     0.0


0.0


  14.1


  –  .3


    2.9


Foreign Stocks- MS EAFE Developed Countries


     .8


  -14.8


-14.8


    4.5


 -7.4


    2.0


Source: Morningstar Workstation. Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly. Three, five and ten year returns are annualized excluding dividends