Monday, January 7, 2013

Almost All of Wall Street Got 2012 Market Calls Wrong…And Will Likely Again in 2013

With a new year ahead of us and plenty of opinions out there on what will happen this year, let’s first take a look back and see how accurate forecasters were one year ago. According to this Bloomberg article it turns out most of them were inaccurate:

From John Paulson’s call for a collapse in Europe to Morgan Stanley (MS)’s warning that U.S. stocks would decline, Wall Street got little right in its prognosis for the year just ended.

Paulson, who manages $19 billion in hedge funds, said the euro would fall apart and bet against the region’s debt. Morgan Stanley predicted the Standard & Poor’s 500 Index would lose 7 percent and Credit Suisse Group AG (CSGN) foresaw wider swings in equity prices. All of them proved wrong last year and investors would have done better listening to Goldman Sachs Group Inc. (GS) Chief Executive Officer Lloyd C. Blankfein, who said the real risk was being too pessimistic.

The ill-timed advice shows that even the largest banks and most-successful investors failed to anticipate how government actions would influence markets. Unprecedented central bank stimulus in the U.S. and Europe sparked a 16 percent gain in the S&P 500 including dividends, led to a 23 percent drop in the Chicago Board Options Exchange Volatility Index, paid investors in Greek debt 78 percent and gave Treasuries a 2.2 percent return even after Warren Buffett called bonds “dangerous.”

link to article

Government actions were an “X” factor this year that most of these forecasters failed to foresee. Brought down by pessimism from a late drop in 2011 many drew a straight line downwards for the stock market. Additionally, Wall Street (sell-side) never really likes to be bold; after all, if they step out too much and are wrong, they will likely lose their jobs!

If they had just taken a step backwards and looked at pure fundamentals, they would’ve seen the discounts equities were trading at (all types of valuation metrics, e.g. P/E, P/B), and should have been even more bullish if they had simply compared the earnings yield versus what a treasury bond yields!

Likewise at the beginning of 2013, the earnings yield for the S&P 500 (inverse of the forward P/E), despite its run up, stands at 6-7% while a 10-yr treasury bond yields roughly just under 2%. If you look at Europe where some government bonds trade at negative yields and many large cap stocks trade at ~10x forward P/E, the absolute spread between the bond yield and earnings yield for some of these markets is even greater. Any rational person would buy equities instead of piling into the bond market. Well, of course, as the title of my blog says it, the market does get euphoric/irrational at times.

For 2013 I see most analysts/forecasters expect a +10-20% increase in the S&P 500 and for many markets. They fret about the Fed pulling back QE3, the fiscal cliff, Europe breaking up, and overcapacity in China. Once again I get the sense they are just drawing a straight line from the end of 2012 and have a lack of conviction on the market. I also get the sense that retail investors are still not buying the stock market yet and are still parked in bonds. Combining these two observations of people still doubting the market uptrend (and thus not displaying euphoria, a sign of the market peak) with the fundamental positive spread between the index earnings yield and bonds, equities still have room to run a bullish course for 2013. To all those pundits who claim the “Death of Equities”, I say, not quite yet!

The forecasters might just get 2013 wrong again. This time though, it’s not the direction of the market they’re likely to get wrong, but the amount the market will move up!