Drives us crazy! Media outlets get eyeballs when things look like disaster. Good news is no news. Unremarked in the last three months: Oil prices down 25%; gas prices down 10% and still falling. Decreasing inventory, a slowing foreclosure rate, increased buyer interest implies that 2012 is the true floor of the housing market, with modest gains expected for 2013. Average Americans have 5 times as much wealth tied to housing as to stocks; any gains there have positive implications for the rest of the economy. The US auto industry, which many observers were ready to write off for good in 2009, reported record profits in 2011. Huh!
Over the next ten years, the US economy is likely to grow by 50%. The Chinese economy may well grow by 100% in the same time span, but the US will still be the largest economy.
Isn't there some way we can jump out of the market at the highs, come back in at the lows?
We get this question every time the market pulls back. "If we thought the market was over-extended back in March, why didn't we raise cash so we could preserve gains, come back now." Market timing is wonderful in principle, but in practice, we have yet to see a firm that has a sustainable advantage, even before backing out trading costs and commissions. At our firm, we mechanically rebalance 1-2 times year to our target allocations, which achieves our long term goal of selling high and buying low. This works very well for our "retirement bracket" clients (60-85) who have benefited from having a high bond allocation over the last ten years. It has been a lot tougher on our "accumulation oriented" clients (45-65) who feel like three steps forward in stocks is followed by three steps backward.
If you were our client who went off on Safari at the end of last year, got back today and called for an update on the markets, we would tell you that the S&P 500 is up 5.6% YTD. "Cool," you would say, and get back to sorting your laundry. It's the up 13%, down 10%, up 3% gyrations that make people crazy. Our fix: turn off CNBC and do something more interesting with your life.
"Should we invest in hedge funds?" Those firms are making leveraged directional bets. Most do well for several years, wipe out in the fifth year. A few make it ten years. A tiny percentage (about 0.1%) makes it 20 years. Those firms do what they do very well, but it's irrelevant to most investors as the funds are closed. The rest are a good deal for the managers, but a lousy deal for investors.
"Should we invest in High Frequency Trading?" As individual investors leave the markets, HFT firms are left trading against each other (Darth Vader vs. Ming the Merciless.) HFT firms make their money scalping the trades of individuals and mutual funds. No trades? No profits!
"Should we invest in private equity?" This strategy depends heavily on leverage, generally "creates wealth" for the general partners, and "destroys value" for pretty much everyone else. With bank financing dried up, the private equity game is pretty much over.
All these options are illiquid, non-transparent and have high management fees. We won't recommend them to any of our clients.
Will 2012 be a repeat of 2011?
Last year, US stocks started off well in the spring as employment grew and the GDP numbers kicked up. The summer was a miserable slog of bad news out of Europe, and by December 31st, the S&P 500 closed with a gain of only 2.1%. Clients' overlay this year's chart on last year's and wonder if another "year of suck" is in the cards. If you want to play that game, why couldn't 2012 be like 2010? That year, stocks had a strong rally in the spring, sold off sharply hitting a low for the year in July, but rallied to close out the year with a gain of 15.1%.
What we do know for sure is that the market will not end up like 2008, with stocks down 37% and still falling because the conditions that created extreme risks at the start of 2008 are not present. JP Morgan's loss on CDS could not have come at a better time to remind politicians that banks need firm regulation, just as the provisions of Dodd-Frank were in danger of being watered down.
Strategy
We feel less certain about the outcome of the US presidential election compared to two months ago. That means we are less certain about many other aspects of the US political economy. The biggest unknown is US tax policy in 2013. At present, US personal income rates will automatically return to higher levels January 1st, unless Congress and the White House can form a bi-partisan consensus prior to the election. Forget about that!
US stocks however, were a good value a month ago and a better value today. With the weak hands forced out by the recent 10% pullback, we are moving forward with investments in stocks. We have talked to so many prospective clients who went to all cash in March 2009. While these prospects have missed out on most of the gains of the last three years, it is reasonable that if they invest today, they will make a decent return by year end. Our forecast remains 12% in the S&P 500 by year end, versus today at 4.6% YTD.
