Being Wrong and Staying Wrong
Before I get into this year’s forecast for the market, let me say a quick comment about humility as an investor. Being wrong about your assumptions, beliefs about the future, is part of the game. Humility is an investor’s best friend as the earlier you accept your “wrongness”; the quicker you can get your money where it really needs to be. Investors will be wrong often, all investors, and not just bad investors. I learned this lesson many years ago – in my twenties, and I’m thankful for the early education. The lesson is not about being less wrong but avoiding the situation of staying wrong and really paying the price in lost opportunity or lost capital.
For instance, at the end of 2012, in the heat of election and talks of Fiscal Cliffs, the evidence in front of us overwhelmingly suggested 2013 was going to be a tough year on all fronts. The case for a garden-variety bear market unfolding in the neighborhood of 15-20% by May was very real to the vast majority of professional investors including ourselves. Subsequently, institutional investors, pension plans, endowments and the most savvy of investors, added defensive positions to their portfolios including Gold, Silver and yes Treasury bonds. Flows of investment capital confirm these moves were made in mass. By February, it became obvious to us that the chance of a large decline was shrinking. Bonds and Gold were in near free falls in price and stocks were breaking out to all time new highs with gusto! This was not supposed to happen. We were wrong and knew we had to make some serious changes. Many were not willing to admit such error suggesting instead that the markets were wrong. Many stuck with their bonds and gold and silver, suggesting the whole market was a dancing puppet of the Fed. Many still do. But they were wrong and are now angry that their portfolios haven’t made much in the way of gains for 2013 – if at all.
We began adding to our stock allocation in February and continued doing so until May when we reached our maximum equity allocations by strategy designs. Our All Season and annuity strategies went from 50% stock to 80% stock, High Dividend moved to a 95% invested position, the highest in over 3 years. New Power and Worldwide were also fully invested. But all of this took some time and we were not fully and aggressively allocated until the late spring. Of course, we have lagged most of the fully invested stock indices in this yearlong process but we’re still pleased with our year-end results. Those who “stayed wrong” are now in a tough spot. They hate their gold and silver (-40%); despise the government for deceiving them and manipulating the markets. They hate bonds (-14%), all bonds and can’t stand watching piles of cash in the bank earn nothing. The Stay Wrong investors are angry not at the world but ultimately at themselves for not having the humility to admit error early and move on. Tough lessons.
Forecast for 2014
I’m a probability-oriented investor. 2013 was a year that broke the probability mold as the market rose dramatically without as much as a 5% correction all year. This is rare, extremely rare. So as a probability guy, I’m going to say with strong confidence that we are going to see an increase in volatility with at least two stock market corrections of 10% or more in 2014. One early in the year and one in the fall.
I think the economy and the stock market is going to go through a transition year but avoid a formal recession or a dramatic collapse in the financial markets. Think of it this way; there is truth to the notion that the Federal Reserve has supported by the economy and the financial markets with their bond-buying program. $85Billion/ month of purchasing power has kept us safe and happy for several years now. This support is coming to end and will be gone by June of 2014 – so says the Fed as of last meeting. Now imagine that first day when we remove the training wheels for our young bicycle rider. There is some weaving, some scary swerves, near misses and maybe even a small tip over. But soon there is that moment, when the smile comes, the arms shoot to the sky and we say, go, go, GO! And our young rider never looks back, never needs the training wheels again and feels the confidence of their own independence. That day is coming, perhaps in 2015. 2014 will be a bit wobbly.
I’m also going to assume that this year’s winners are not also going to be next year’s winners. Now is the time to start buying those things, sectors, countries and asset classes that present greater value or for whatever reason have failed to participate in this year’s frenzy. Sales should happen in securities that are obviously no longer good values and there are many that fit this description. Generally for taxable accounts, we are waiting until the new year to do these sales so as to push capital gains tax liability into 2015. But for tax-deferred accounts, anytime around here is a good time.
In terms of sectors themes, it seems that 2014 will still be good year for cyclical sectors but specifically those that are late cycle leaders. These are more hard asset type companies found in the industrial, technology hardware (and software), energy, basic materials, andhomebuilders. Outside of those sectors that make stuff for our growing economy, I still like the banks and financials, which still represent some of the best values and are poised to benefit from a rising interest rate environment. On the unattractive side, I would avoid things that have run too far too fast or those that represent recession trades. The chance of a recession now is very slim. To you that means cut back on healthcare, consumer sectors (discretionary and staples), utilities and of course bonds and gold if you haven’t already done so. Interest rates and the US dollar will be rising gradually and erratically now and for the next 3-5 years. Bond and precious metals prices will also be falling. In terms of country preference, I’m hopeful but not expecting a rebound in emerging markets while US rates are rising. China and Asia are not as dependent on low US interest rates so if you’re going to go international stick with Asia and Europe for 2014. Right now, internationals are a better deal than US stocks on valuation alone. The smart investors will look for companies that derive revenue from many different countries as their international exposure. Picking one country or another is a bit ofcrapshoot for 2014.
Subjectively, I see the next 3 years being tough on the current president. Wealth is on the rise, incomes on the rise and tax rates are on the rise. This is not a function of president Obama but the price we all pay for nearly two decades of government financial support of a faltering US economy. I have no doubt that by 2016, the next president will be a Republican as the system will feel it doesn’t need the help of a democrat in office anymore. I think the Affordable Care Act will be completely retooled or removed in 2014 because it is a genuine disaster as is.
If I had to forecast anything about investor behavior, it would be this; 2014 will be another year where an investor needs to stay flexible, both in their allocations and their assumptions about the future. I see much money flowing into things that have already run past the point of reasonable. Netflix, Facebook, Pandora and Tesla need a long break after this year and yet I watch the share volume and see many millions on the buy side. In our speculative New Power model, we have sold our big winners and are looking down, not up, for new opportunities.
With that, I’ll wrap up my 2014 forecast and hope that if I’m wrong I have the mental strength and humility to avoid staying wrong for longer than necessary.
529 Investors – Make Your 2013 Contributions (to cash)
As I said earlier, 2013 was not a year that offered ANY reasonable low risk entry points for new cash. We did not have a 5% correction during the entire year! Our strategy within the 529 investor space is to encourage adding money on market discounts as we have only one “investment allocation” change per year (Ridiculous!). The best we can do to manage risk is to buy low right? But now we’re against the fence and have to get our contributions done before the end of the year in order to get the state income tax benefit. I am recommending that contributions be made now in full, but direct the contribution to cash, without changing the allocation of funds currently invested. In 2014 when we get our first discount or correction, we’ll get that money to work at a better level.
The current limits on contributions are $14,000 per parent, per child for calendar year 2013 – so $28,000 for joint filers if you have the cash flow and want to do it.
And with that, I’ll wish everyone a fantastic holiday and a happy new year. There will be no weekly update next week.
Cheers
Sam Jones
