At the beginning of 2012 we wrote how analyzing market performance needs to be more involved than a simple calculation of return for the calendar year. January 1 and December 31 are very arbitrary dates to Mr. Market who does not care about starting and ending points. Eve worse are prognostications for that same random 12-month period. By definition, if enough forecasts are made, someone is likely to be close to the year-end market level. A year ago, the most ‘accurate’ forecaster reveled for months in his prescience, giving interviews, doing TV appearances, and writing about his stellar forecasting methodology. His forecast for 2012? Not so good. He will be off by about 30%.
What does he say now? “We felt little joy in 2011 and lots of pain in 2012 related to the target, and find few credible investors really care where we think the market is going to be on a particular day one year in the future. What they more often care about is the logic and thought process, and the empirical evidence that support it”. As a matter of fact, over 90% of the forecasts for the end-of-year S&P 500 level were too low as we look back. But there is nothing gained in looking at those forecasts and making assessments about the analysts making those predictions. As stated by the popular forecaster above, investors should care more about the logic and thought process that goes into a strategy or outlook.
It is really with that in mind, that we write our annual Outlooks or even our quarterly Big Picture Views. They provide a look into the process of our Investment Committee’s work and strategies. Inherent in any of the comments or analysis made in this piece is a certain amount of flexibility. While we pride ourselves on being consistent and disciplined, there is an overriding awareness of changing risks in the market which we will do our best to hedge, reduce, or eliminate.
Current headwinds threaten a lot of assets. However, if we could get through some of these nearterm stresses, there are tailwinds that can create momentum going forward such as a soft-landing in China, cash on corporate balance sheets, the number of tail risks having diminished, tremendous liquidity provided by central banks, a deleveraged consumer with confidence that is recovering, and an improving housing market. Building portfolios that can benefit from these reduced risks should be rewarding and we do have an optimistic outlook for the New Year, but there has to be a balance given that risks are still present and are outsized relative to investors’ past experience.
Sometimes the balance that is struck means missing parts of certain rallies, but as we have tried to highlight, measuring returns in any single period of time can yield inappropriate conclusions. For instance, in our opinion, it has been highly prudent to maintain caution in the bond market notwithstanding the bull-run that has seen yields dip to 1.4% for 10-year risk. We elaborate on this point in this Outlook, but the reward for chasing returns in bonds are not significant enough to cushion against the potential downside. Clearly, exposure to the asset class is important, but a mitigation of risks will be highly beneficial at some point when yields rise. That kind of management is what we extol and incorporate into our strategies.
As always, we write our strategy pieces as much for our own benefit as for clients. We are not trying to sell anything or pound the table for any specific thesis. We attempt to articulate the case for our current portfolio posture and develop some sense of changes that will be sought to react to changes in the market. Hopefully these efforts will create insight for everyone as we go forward.
Best Wishes in 2013!