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Forecasting and the New Year

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“We have two classes of forecasters: Those who don’t know and those who don’t know they don’t know.” - John Kenneth Galbraith

By now the New Year has settled in and many of us are back at work picking up where we left things off in late December. Typical for this time of year, we hear from various market seers as they critique past financial forecasts and then make up a new list of likely or even surprise occurrences they believe could play out over the coming months. Aside from the entertainment factor, most of these forecasts are not worth the paper they are written on. This is not to say that the authors are dim, quite the opposite. They are usually very bright, well spoken, and possess sound logic.


Most people realize that consistently forecasting the future accurately is an extremely difficult feat to accomplish, no matter how smart the individual or the complexity of the methods employed. Through experience of crunching the numbers first hand, I have found the more complex the model, the less useful the output tends to be. This is particularly true when it comes to business and economics forecasting (Figure 1), which makes the key assumption of rational actors and normal probability distributions. As a result real world financial time series data exhibits an unusually high level of outliers.


With this in mind, most forecasters were not predicting the extreme beating global equity indexes took to kick off the year. According to data from The Wall Street Journal, weekly returns for the Dow Jones Global Total Stock Market Index were off by -6.12%. While Barron’s exclaimed in this past week’s edition that, “The stock market got off to its worst January ever as major market indexes fell 6% to 7% last week.”


Now the stock market bears among us are furiously typing up their blog posts and will likely be given extra space in the financial media as they warn of the coming doom that will follow this abysmal week. Their reasoning makes sense and is most likely based on richer than average valuations, a tightening Fed, contagion from China, and weak US/Global GDP. All true. However, please keep in mind that many of these commentators completely missed the stock market rally that has been going on since 2009, where the S&P 500 index bottomed and then more than tripled into 2015, proceeding to make new all time highs (Figure 2).


I sympathize with the bears and agree that the market is over-valued based on most metrics. As a result, I am managing portfolios with this in mind and have advised clients to assume a considerably lower equity and “equity like” asset allocation compared to normal times, as the secular bull market is surely closer to its final innings. However, in my opinion the stock market still has gas left in its tank, as I believe valuations will become even richer as we work our way through 2016.


Richard Bernstein, of Richard Bernstein Advisors is a well-known market analyst and the former chief investment strategist at Merrill Lynch. He was recently interviewed on the television show “Wealth Track” with Consuelo Mack. I highly recommend tuning in if interested in hearing a well-reasoned, straightforward point of view (click here to view the interview). I found his ideas compelling and his thought process creative as opposed to linear and typical. To sum up his thoughts, he believes we are still in a secular bull market as institutional and individual investors never really participated or believed fully in the equity market rally, as they have been underweight stocks since the 2007-08 financial crises. Second, market analysts are too focused on the economy and not focused enough on corporate profits, which have become over the past few years the largest percentage of GDP in history. It is future corporate profits that equity investors should care about, not GDP. And third, which is more of a warning to investors that this year is going to be more volatile than usual given 2016 is a Presidential election year. Meaning that both political parties will be slinging lots of mud around as both the standing President and Congress have very low approval ratings. As a result, the candidates from both parties will be talking up how terrible things are and that change is sorely needed. Expect the media to add fuel to this fire, which predictably will be serving up fear.


Lastly, I came across this graph (Figure 3) of the weekly S&P 500 sentiment survey from the American Association of Individual Investors (AAII) that was posted by Bespoke Investment Group. As many readers are aware, market strategists believe that overly bullish sentiment signifies market tops while overly bearish sentiment signifies market bottoms. We are closer to an extreme bearish reading which if good for anything could mean we are due for a market bounce over the coming weeks. Nevertheless, readers should be reminded that short term trading is not what we do at Pacificus Capital Management. We manage portfolios with long-term objectives in mind taking into account each client’s comfort level in relation to an acceptable amount of market risk. As investors, we generally cannot consistently predict the market, but we can take a disciplined objective approach, always careful not to miss the forest for the trees.



Sincerely,

Justin Kobe, CFA Founder & Portfolio Manager


Securities and Advisory Services offered by Protected Investors of America, an SEC Registered Investment Advisor. Member FINRA/SIPC. The views expressed in this commentary are the personal views of Justin Kobe of Pacificus Capital Management and do not necessarily reflect the views of Protected Investors of America. There is no assurance that the investment process will consistently lead to successful investing. This commentary does not constitute an offer to sell any securities or the solicitation of an offer to purchase any securities. Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.

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