2014 Fearless Forecasts – Looking Back and Gazing Ahead

Each year in my January newsletter (“News and Views”) I make a number of predictions about the stock market, the domestic economy and maybe a few key trends. At the same time, review the accuracy, or lack thereof, of my Fearless Forecasts from the prior year. So let’s first see how my prognostications from last year panned out before I make this year’s prognostications. The forecasts are in black and the actual results are in red.

  1. I think the broad markets will be only modestly higher in 2013. Put me down for an 8% gain for the Dow Jones Industrial Average, which means a closing price of 14,156. That, coincidentally, would be six points below the all time high of 14,164.53 from October 9, 2007. I think the S&P 500 will lag the Dow this year, limiting the S&P to a gain of only 6%, which means a closing price of 1,508. As usual, the market will not rise in a straight line. Indeed, there will likely be two corrections of between 5 – 10%. But again, investors who hold tight will be rewarded. I was right about the direction of the market, but not the magnitude. The DJIA finished up 26.5% and the S&P 500 ended up 29.6%. There were three corrections of between 5 – 10% (they were each around 6%). Buy and hold was definitely the way to go.
  2. I’m confident the Fed will leave short term rates unchanged for the entire year; they’ve already declared as much. I also believe that there will be no more “quantitative easing” plans as the risks of inflation outweigh the concerns about deflation. I think the yield on the 10-year Treasury will stay in a range of 1.50% – 2.00% and the 30-year bond will remain roughly 1.00% higher than the 10-year. Mixed result here. I was correct that the Fed would leave short term rates unchanged and that there would be no more QE. The 10-year Treasury broke above 2% in June, establishing a new trading range between 2.5% – 3.0%. The 30-year bond yield did indeed remain about 1% higher than the 10-year. 
  3. I think the value of the dollar will be lower by the end of the year, after finishing 2012 around 80. Countries all over the world are attempting to devalue their currency in order to bolster their exports and the U.S. is no exception. I expect the dollar index to trade between 73 – 83. I wasn’t too far off. The dollar finished the year right where it started, around 80, after trading as high as 85 and as low as 89 with a primary trading range between 79 and 83. 
  4. I think slower global economic growth this year will limit demand for West Texas Crude, thereby keeping the price down a bit. That being said, I think the price of WTIC will stay for much of the year between $80 – $100, although it wouldn’t surprise me to see it briefly drift as low as $70. This prediction was reasonably accurate as the price traded between $90 – $100 for much of the year, with a three month spike during the summer. There was very little downside movement.
  5. The price of gold has moved higher in each of the last 12 years, even as the rate of growth slowed a bit last year, and I’m confident it will go higher again this year. My upside target is about $1,850 per ounce while the downside is about $1,600. The primary trading range will probably be something like $1,650 – $1,750. I think the price of silver could test $40 per ounce again, but will likely remain in a tight trading range between $26 – $36. I don’t see silver going much lower than $25. Unfortunately, I could not have been more wrong with my predictions for the precious metals sector, which completely tanked last year, as the price of gold plunged almost 30%. Silver fared even worse, finishing the year down about 40% from the high. This one hurt.
  6. The housing market will continue to rally in 2013. Average prices will slowly rise throughout the year as inventory remains very tight. Interest rates will remain historically low, although they will likely be higher by the end of the year. This was mostly correct. The housing market, as represented by the HGX housing index rose 23% in the year. Housing starts increased 11%. New home sales rose 17% but existing home sales were flat. Prices in both new and existing markets rose nicely. Interest rates, although higher than 2012, did remain historically low in 2013.
  7. I think the average rate of GDP growth over the next four quarters will be around 2.0%, which is slightly lower than 2012. Q4 2012 may be the high water mark as the first half of 2013 could struggle to reach 1.75%. The average rate of growth of GDP for the last four quarters was exactly 2.0%, although the good news was that the rate of growth increased all four quarters, accelerating nicely in the second half of the year after a very laggard first half. 
  8. For the third year in a row, job growth, or the lack thereof, will continue to be one the most important domestic stories of the year. The unemployment rate will likely top out around 8.0% and will fall to only 7.5%. The U-6 measure for unemployment, a more accurate gauge of the true unemployment situation, will likely remain in the 14%-15% range. The other big story will of course be the federal deficit. There was solid improvement on the employment front last year. The unemployment rate fell from a high of 7.9% to a low of 7.0% in November, while the U-6 fell from 14.4% to 12.7% over the same period. And the fight over the deficit caused a government shutdown. 

All in all, my forecasts were a bit of a mixed bag, but except for the horribly wrong forecast for gold  I wasn’t too far off last year. And remember, I have no formal training in economics. I’m just someone who closely observes what is happening in the world and tries to apply that knowledge to my investment management business. Anyway, last year is history now; it’s time to look forward, which means a new set of Fearless Forecasts. So without further ado, here we go:

  1. I think the broad markets will again finish higher in 2014. Put me down for a 12% gain for the Dow Jones Industrial Average, which means a closing price of 18,565. I think the S&P 500, with a greater emphasis on tech and growth, could do a little better, finishing up 14%, for a closing price of 2,106. As usual, the market will not rise in a straight line. I expect there will be two or three corrections of between 5 – 10%. One could even be worse than that. But investors who hold tight will be rewarded.
  2. For the second year in a row I believe the Fed will leave short term rates unchanged. I also think the Fed will reduce their bond buying program to at least $40 billion a month by year-end. If they economy is strong enough, they could have it down to zero. The yield on the 10-year Treasury will remain in a relatively tight range of 2.75% – 3.25%.
  3. For two years the dollar index has traded between 79 and 85 and closed the year around 81. Given the reduction in QE, a falling deficit and trade gap, I expect the dollar will be 5% higher, or about 85, by the end of the year.
  4. I think an improved global economy this year will increase demand for West Texas Crude, putting upward pressure on the price. On the other hand, increased supplies from shale drilling will be a drag on prices. Therefore, I expect the price for a barrel of oil to remain relatively range-bound in the $90s for most of the year, with a low of $85 and a high of $105.
  5. After 12 straight years of increases the price of gold fell last year, and fell hard, finishing around $1,200/oz. Longer term, meaning over the next few years, I think gold will move higher. Before that however I think gold will drop below support at $1,200, falling to as low as $1,000.The yearly high is tougher to judge, but I’ll estimate the high to be no better than $1,400.
  6. I expect the housing sector to continue to rally in 2014, albeit at a measured pace as slightly higher interest rates inhibit a faster rate of growth. The volume of new and existing home sales will rise by no more than 5% and average prices will gain slightly less as inventory rises.
  7. I think the average rate of GDP growth over the next four quarters will be around 3.0%, a marked increase from the prior four quarters. I expect the first two quarters to have a higher rate of growth than the second two.
  8. Real job growth, or the lack thereof, will continue to be one the most important domestic stories of the year. The headline unemployment rate could fall as low as 6%, and will likely be no higher than 7%. The U-6 measure for unemployment, a more accurate gauge of the true unemployment situation, will likely remain in the 12.5%-13.5% range. The bigger problem is the dismal labor participation rate, which has fallen to a thirty-five year low of 62.8. That measure must improve in 2014. 
  9. Finally, I don’t believe the mid-term elections will do much to change the political landscape. Congress will likely remain divided. I do expect the The Tea Party to be marginalized as the electorate realizes that a hyper-polarized Congress cannot govern at all.

Market Achieves Record Levels

About an hour into trading today, the S&P 500 and the Dow Jones Industrial Average have both surpassed previous all time highs and achieved significant milestones. As I write this around 10:30am, the DJIA is at 15,003, marking the first time in history the venerable index has reached that level. Similarly, the S&P 500 is at 1,616, the first time that index has ever been over 1,600. And the Dow Jones Transportation Average is only 7 points below its high. Should the DJTA move to record levels concurrent with the DJIA then we’ll have a bullish confirmation according to Dow Theory. This is all great news.

Yet surprisingly, given these lofty levels, the overall enthusiasm seems relatively muted. There are no fireworks, no parties on the floor of the stock exchange and relatively muted commentary on CNBC. I think that’s a good thing. It suggests that this in not a period of “irrational exuberance”, like 1999. Corporate balance sheets and earnings are in much better shape than in 1999 or 2008 and the global economy continues to be propped up by central bankers. So as long as the money continues to flow unabated, the good times should continue.

That being said, it appears to me that market sentiment remains relatively bearish, or at best very overly cautious, despite the record levels. I think too many individual investors have remained on the sidelines since the crash in ’08, missing out on this stupendous rally. Also, the plethora of contradictory economic news, both in the US and around the world, has left market participants confused and scared. It seems as though every day one economic statistic reveals a slowing economy while another suggests that everything is more robust than expected. Earlier this week the PMI data indicated that the manufacturing sector was slowing. Comments by the Federal Reserve seemed to confirm that thesis. Yet today it’s all wine and roses after the BLS released a stronger than expected employment report. More jobs were added than expected in April, and February and March were revised higher. Additionally the unemployment rate dropped to 7.5%, the lowest level since the crisis began.

It’s possible that since the DJIA and S&P have now breached important psychological barriers that the rally will really take hold as cash begins to move from the sidelines and investors and money managers who have under-performed the market rush to add equity positions. If that is the case, the broad market could move markedly higher from here, dispelling the old adage to “sell in May and go away”.

Conversely, these lofty levels could spur some investors to take some profits and wait for the inevitable correction. We’ve already had a great year after only four months. I certainly would have signed up for a 12% return for the year. If this momentum continues, we could be looking at 20%+ returns for the year. Only time will tell as there is still a long way to go before the story of the market for the year is fully written. Personally, my clients and  I remain almost fully invested, but we’re selling weaker holdings into the rally to raise some cash for the next buying opportunity.

Fiduciary Duty From Your Advisor

This week, I’d like to talk about fiduciary duty. I will be borrowing liberally from an article written by Knut Rostad in the February 11, 2013 edition of Investment News. Mr. Rostad is the president of the Institute for the Fiduciary Standard, a nonprofit formed to advance fiduciary principles through research, advocacy and education.

By way of background, fiduciary law was established to mitigate the knowledge gap between expert providers of socially important services, such as law, finance and medicine, and consumers of those services. Mitigation is accomplished by legally requiring those experts to put the interests of the consumer first, ahead of their own interests.

According to the article written my Mr. Rostad, the following are the six core duties of a fiduciary:

  1. Serve in the client’s best interests – no divided loyalties
  2. Act in the utmost good faith – be honest, truthful and accurate
  3. Avoid conflicts of interest – maintain objectivity
  4. Disclose all material facts and conflicts – make clear, complete and timely disclosures of all material facts and disclosures
  5. Act prudently, with the care, skill and judgment of a professional – use best practices and update knowledge and expertise regularly
  6. Control investment expenses – ensure that all fees, costs and expenses passed to the investor are fair and reasonable

As an SEC-registered investment advisor, I’ve maintained a fiduciary standard in my practice since I formed my business almost 16 years ago. I spend a lot of time with each new client explaining what my being a fiduciary means to them, how that differs from a “sales” perspective, and how that impacts our relationship. I believe strongly that all investors should demand a fiduciary standard from their advisors as it helps to minimize potential conflicts and more closely align the interests of both parties. The next time you speak with your financial advisor, ask him if and how he holds himself to a fiduciary standard.

Unspoken secrets in the money management business

The past few weeks have been dominated by storms, literal and figurative:  the election, the fiscal cliff, Sandy, the nor-Easter and now infidelities. It was enough to give me a brain cramp and writer’s block. Rather than talk more about that which has been discussed too much already, I thought today I’d share with you some of the unspoken secrets in the investment management business because they have potentially serious implications for your money. And that is, after all, what I’m supposed to be writing about.

Professionals in the investment business, whether they’re called stockbrokers, investment advisors, financial advisors, money managers, or something else entirely, are often described as “playing with other people’s money (OPM)”. That phrase alone should give you pause as it suggests a carefree attitude to investing by the pros because it isn’t their money. The idea is that a client gives you money, and you employ some method to decide how to deploy those funds, then you sit back and collect your commission or your fee. One of the unspoken truths in the industry is that few of these professionals are the ones that actually invest the money that they are paid to manage. Indeed, they usually farm that responsibility out to someone else.

Oftentimes, once the advisor has your money, he will usually either hire someone else entirely to manage the money, or rely on his research department pick the investments for you, or put your cash into pre-determined “model portfolios”, or simply dump the money into a bunch of mutual funds according to the asset allocation tenets of “modern portfolio theory”. More often than not, advisors are simply cash aggregators; accumulating as much money as possible, thereby generating the largest fees possible. How that cash is actually invested, and by who, becomes secondary. And to compound the problem, since it’s just “other people’s money” he has no personal stake in how your money is ultimately invested because it’s your money, not his, that’s at risk. And that’s where I’m different.

I make 100% of the decisions as to how my clients’ money is invested. The buck clearly stops with me. And as importantly, I have 100% of my own money, and that of my children and other family members, invested in exactly the same securities as my clients. Indeed, I personally own 29 of the largest 30 positions owned by my clients. I am clearly talking the talk AND walking the walk. My general rule is that if it’s good enough for my clients, it’s good enough for me and my family. I wouldn’t buy anything for my clients that I wouldn’t buy for my own children.

So what does this mean for my clients? It means I have my skin in the game, right alongside theirs. That I will not take any risks with their money that I wouldn’t take with my own. And it also means I am DIRECTLY accountable for the money that I’m managing on their behalf. Can your advisor say the same thing? Have you ever asked your advisor who is actually managing your money and where his own money is invested? Maybe it’s time you did.