Friday, February 17, 2012

Predictably Unpredictable

By Eric Burkholder, Portfolio Manager
A 2011 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
Entering 2011, many investors had great hope in the world economic recovery.  Equity markets had just tallied two straight years of strong performance, central banks remained committed to low rates, and major developed countries were working to resolve debt issues.  As would be expected, pundits were out in full force predicting another great year for stock investors.  A survey conducted by CNNMoney of 32 “experts” found the average prediction for the 2011 S&P 500 return was 11%.  In fact, not one of the experts thought the S&P 500 would decline.[1]  How accurate were they?   The S&P 500 ended exactly flat in price at yearend and eked out a 2.11% return with reinvested dividends.
Even with such optimism in the air, the market Bears were not to be outdone for 2011 predictions. Perhaps most notably was Meredith Whitney’s call of the Muni Bond collapse.  For 2011 she predicted “hundreds of billions” of municipal bond defaults.  The prediction actually induced a short term sell off in the muni bond market, but ultimately she was shown to be spectacularly wrong and municipal bonds finished off the year as one of the best performing asset classes with a return of 11.2%.
By mid-year, however, optimism faded as troubling events around the world dominated headlines. The devastating earthquake and tsunami in Japan, political unrest in the Middle East, rising oil prices, a US credit downgrade, the threat of another global recession, and an escalating debt crisis in Europe weighed heavily on markets. As stock market volatility returned to global financial crisis levels, investors faced a major test to their discipline and staying power.   The sanguine predictions from January 2011 were soon long forgotten and the Bulls pulled in their horns.  However; the doomsday economists were happy to fill the void.  The ECRI (Economic Cycle Research Institute) touts their record of calling market turns and will give you access to their data, for a small fee of course.  In September this year they issued a report which stated:
“Early last week, ECRI notified clients that the U.S. economy is indeed tipping into a new recession. And there’s nothing that policy makers can do to head it off.”[2]
It appears for the time being they missed the boat on the US economy, which showed surprising strength in the fourth quarter despite the Euro Zone crisis. And finally, there was Gold.  The world exploded with talk of the yellow metal this year following its historic rise which began in late 2007.  The “End of America” was imminent and only gold would save us.  Numbers such as $2,000, $3,000, and even $5,000 per ounce were being thrown in the whirl wind of projections and no estimate felt too high.  JP Morgan’s pick: $2,500/oz by the end of the year.[3]  With all the hype many of us began to ask:  “If Gold is going to be so valuable, why are they trying to sell it to me so badly?”  The question was partially answered when the Alluring Aurum ended December at $1,531/oz, or 23% off its 2011 high.  Gold has had a spectacular rise, but the 1980’s taught us the fall can be just as impressive.

These illustrations are not meant to prove the economy is guaranteed to blossom in 2012 or that there will be continued wilting.  What you can take away as you review the market events from 2011 and look towards 2012 is that two things did happen exactly as expected.  First, history has shown that “expert” predictions are almost never accurate, 2011 was no exception.  Secondly, markets last year were consistently capricious affirming that a globally diversified asset allocation portfolio is still the best way to build long term wealth.

[1] Stock outlook for 2011: Recovery rally will continue – CNNMoney

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