| Predictions for 2012 |
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When it comes to making predictions, people, and especially market analysts, fall into two basic camps.
The first is the camp that takes itself and its predictions very seriously. More often than not, money is involved. Or ego. These people are either paid by their employer firm to predict the future or their services are purchased by individual investors. These guys hate being wrong. Because when they’re wrong, nobody loves them. They lose customers or get fired. There’s a lot at stake! And the problem is that they’re faced with an impossible endeavor. No man can truly know what tomorrow brings, and if one does manage to guess it right for a few days in row, it’s only a matter of time before he’s wrong.
The second is the camp that doesn’t do them. These guys know that predicting the future is impossible. They avoid the act altogether, and while sitting on the sidelines, they laugh at the futility of those in the first camp.
The problem is that investing is a necessarily speculative endeavor. By definition, any time you make an investment you are expressing a view about the future. Even parking your money in cash is a way of expressing the view that none of the investments on the menu will be worth the future risk. So denying the reality of speculation is every bit as ridiculous as thinking that someone really can predict the future with accuracy and consistency.
This is why investing is so damn hard. It involves synthesizing two diametrically opposed philosophical worldviews.
I think this necessitates the existence of a third camp. Folks in this camp understand that adopting a forecast is necessary, but they don’t take it too seriously. They keep an open mind about it, accepting of the fact that it could be totally wrong. Should that happen, the best they can do is change their opinion and get with the new program as quickly as possible. These guys make predictions (and investments) and neither beat themselves up about it when they’re wrong nor get too excited about it when they’re right. The goal is to learn.
Our annual predictions are an important endeavor for me. I have a lot of fun with it — but maybe that’s just the scientist in me. I enjoy formulating a hypothesis, testing the results, and discovering not just whether the hypothesis was right or wrong, but why it was right or wrong.
So dust off those Zoltar hats and let’s do this!
I’m going to do things a little bit differently this year. I thought it might be helpful to illustrate more of the process for how I make these forecasts. Just because it’s impossible to predict the future doesn’t mean I throw this stuff out there willy nilly.
The Baseline
Here is a sampling of some of Goldman’s predictions for 2012. This should serve as an effective proxy for the consensus.
- 2012 U.S. real GDP up 1.8%, and global GDP up 3.2%;
- 2012 S&P 500 operating profits of $100 a share;
- year-end 2012 S&P 500 price target at 1250;
- 2012 inflation of +1.7%; and
- 2012 closing yield on the U.S.10-year Treasury note at 2.50%.
The Broad Environment
I’ll start by framing the economic backdrop. I think this is one of the easiest things to do, and when you start at the top, the rest of process almost writes itself. Keep in mind that every year crazy things like the Japan earthquake swirl out of nowhere. These are the things that are impossible to predict and when they happen you have to be prepared to go back to your baseline forecasts and ask if they need to be revised.
Thematically, I see four major issues shaping the environment in the year to come.
The first is Europe. I know this was a big deal in 2011 and it was a big deal in 2010. Guess what. It’s going to be a big deal in 2012 too. Sorry about that. The European Union is one of the biggest, boldest economic experiments in the history of humankind.
It seems fitting that the whole thing was conceived and installed during the 1998-2001 frenzy of global euphoria. In retrospect, that was probably the only kind of environment where anybody would be crazy enough to embark on such a wild endeavor. Imagine if the European Union didn’t exist. Would anybody be trying to create it today? I hiiighly doubt it. That should tell you all you need to know about the EU.
Europe’s in a real jam right now. It’s not complicated. The root problem is very simple. There is a whole lot of debt that isn’t worth what a lot of people are hoping it’s worth. The solutions are where things get tricky. So far, nobody has come forth with any good solutions and the reason is that there aren’t any. They all involve pain.
The good news about Europe is that I think it becomes less of a major global story as the year goes on. 2012 will be the year where it slowly leaves the headlines but remains a significant fundamental issue. In this sense, their sovereign debt crisis will follow the same path as our mortgage crisis. People will come to terms with it and lose interest in the headlines. In the background its effects will continue to be felt.
The second thing to watch is the election. Like it or not, 2012 is going to be all about the election. Again, sorry about that.
As with Europe, the election is a big deal for a legitimate reason. This is going to be one of the most important presidential elections in a long time — not because who’s running, but because of what’s at stake. We’re at the point where the U.S. needs to change its trajectory or else the whole thing may spiral out of control.
Do you guys remember that scene in Back to the Future III where the locomotive has to push the DeLorean up to 88mph? If Doc and Marty didn’t get the train up to a certain speed by the windmill, then it wouldn’t be able to stop in time and the whole rig would fly off the edge of the ravine and they’d be stuck in the Old West forever. Well, the U.S. structural imbalances are past the windmill right now. We’ve got to shake things up or we’re going to fly off the ravine. Train crashes are never pretty.
I wouldn’t say that the market has taken on a view of the election yet. But it will. It always does. Once a Republican candidate is selected and we get closer to fall, the market will have something to say about how it feels about each candidate. If it looks like it’ll be a close race, you’ll probably see a little extra volatility. If, by September, the election appears to be a foregone conclusion, the market will price in its moves and that’ll be that.
The side effect of this 2012 election is that not a whole lot is going to get done in Washington D.C. this year. These two parties are playing a very high stakes game right now. Nobody’s going to budge on their principles. Nobody’s going to compromise. Not until the election results are in. So don’t expect any significant, market-moving acts of legislation. All of that will be up to the Fed.
The third major issue is the U.S. consumer. We talked a little bit about this guy in 2011, but he’s going to be a much bigger story in 2012.
My thought is that he’s going to take a break and retrench a little more. I think he’s tapped out for now. With all the uncertainty swirling around us, I think he re-enters his cocoon and hangs out for a little while. Nationwide, I’d expect most people to have to make some difficult decisions in the coming year. The consumer is still in a little over his head. His income isn’t rising and he still has more deleveraging to do.
Assuming this plays out as I think it will, I think that consumption takes a bit of a hit in the coming year.
It’s possible that the market is seeing this too. Stocks like Best Buy, Radio Shack, Amazon, Target, and Bed Bath & Beyond have all struggled to various degrees lately. Stocks like Wal-Mart, Family Dollar, and Dollar General have shown tremendous strength.
Anyway, I think the economic data for the first two quarters, and possibly even the first three, will be very soft. But my gut tells me that next Christmas could be a legitimately good one. I wish I had some better data or analysis to base this on, but it’s a 100% gut call. I can easily see a story where the consumer struggles and saves all year and then cuts loose a little bit for the holiday season. We Americans can only be so responsible for so long.
The fourth and perhaps most important issue in 2012 is China. Last year was a surprisingly quiet year for China. The next one will not be.
I’ve been cautious about China for a while. I’ve been quiet and modest about my caution, but lately my concerns have been rising quickly. I think this will accelerate through 2012 and we’ll embark on the biggest national discussion about China since the boom years.
This time, though, the Chinese conversation will take on a different dimension. Rather than taking the form of nationalistic worry over a country on the rise and playing funny games to the detriment of the U.S., the new Chinese discussion will be one about how its slowing down will (or won’t) affect the global economy.
Remember all the rhetoric a few years back about the manipulation of the RMB for trade gain? That’s less of an issue now. The RMB has been slowing appreciating for a while now and the anxiety over an artificially depressed currency is subsiding. I wouldn’t forecast RMB weakness any time soon, but the reality is that, for a lot of reasons, other parts of the world are getting better and better at competing with China.
There are some massive bubbles in China right now. Many are obfuscated because the economy is still largely managed by the government. But the obvious concern is real estate. Their economy will slow in 2012, and the questions will be 1) how much, 2) to what extent does the real estate bubble exacerbate the slide, and 3) to what extent does this impact the rest of the world.
One of China's "Ghost Malls"
So that’s the backdrop. Wild cards aside, I think it’s pretty safe to say that those are going to be the themes that drive the coming year.
From that, we can now make a few more specific predictions.
1. The U.S. enters recession, or close enough to it that the only people who really care are fellows of the NBER and industry geeks like myself.
The Fed is out of gas. Don’t expect much economic help from them. They’ve done what they can, and while I do see a QE3 as a virtual certainty in the next 12 months — whatever form it takes — I’m not sure how much more the Fed can move the needle. If they could have done something with dramatic impact, I think they would have done it by now and it would have had some effect.
Growth is slowing from other parts of the world. Europe is probably in a recession as I type this up. China is cooling off. South America isn’t as awesome as it used to be. Japan is still an economic black hole.
Growth here isn’t looking so promising either. State and local governments remain strapped, grappling with the challenges of slower growth and a new tax trajectory. The Chicago Fed National Activity Index (the neatest economic barometer you’ve never heard of) has started to accelerate towards the downside.
The good news right now in the U.S. economy is that the corporate sector is running hot. Profits are about as big as they’ve ever been and so are profit margins. Consider this: the companies in the S&P 500 have been every bit as profitable in 2011 as they were back in 2007 with a significantly smaller labor force in an arguably weaker economy. There is only one word to describe how these large businesses have performed in the wake of the financial crisis: studly.
The thing about margins is that they go up and down in big cyclical trends. By definition, pockets of the economy with abnormally high profit margins attract new entrants (competition) which then brings down the aggregate margins of that abnormally profitable pocket. The mean-reverting nature of profit margins is a perfectly normal part of any quasi-capitalist economy.
Remember the GDP equation from your Econ 101 class?
GDP = G + I + C + Nx
G = Government Spending
I = Investment
C = Consumption
Nx = Net Exports
From that equation, we know that G isn’t going to get much bigger. Not in an election year and not with the Fed out of gas. We know that Net Exports aren’t going to get much bigger, not with all our trading partners on shaky ground and the Dollar looking rather strong. And it’s doubtful that the I component gets any bigger, not with record high margins and the corporate sector so concerned about soft demand.
So here in the U.S., it pretty much all comes down to the consumer. How much is that C going to grow?
Before you answer that question, ask yourself this one or take it to your buddies at the club: do you plan to spend more in 2012 than you did in 2011, less, or about the same?
My guess is that most people in the middle class won’t be spending more.
At the lower end of the income spectrum, the number of individuals eligible for unemployment benefits has been dropping steadily all year (as the 99 week eligibility period expires). That’s a certain, albeit not economically-important, consumer that’s effectively dropping out entirely.
I know it sounds really silly, but RV sales have collapsed lately. You should take it seriously, though, because there exists a rather strong correlation between RV sales and GDP. It isn’t without reason. Remember, individuals consume based on expectations of future income. When consumers feel great about the future, they make big ticket purchases. When they feel nervous about the future or plan to retrench, they don’t go out and buy a new RV.
I actually think the U.S. economy will be better next year than a lot of places. In a relative sense, I’m actually quite optimistic about the U.S.. But not in an absolute sense.
Recessions, by definition, aren’t known until after the fact. So this could be the kind of thing where there’s a lot of debate by the end of the year regardless of how the data actually read. There will not be a formal declaration of recession next year. But that doesn’t mean that a lot of people won’t be talking about it.
To put a finer point on it, I think the economy next year will be the weakest we’ve seen since the crisis. GDP might slip into negative territory, or it might be between zero and 1.5%. At some point next year a serious debate heats up about whether or not the economy is currently in or is on the brink of recession.
After the latest round of economic data, I’d say that consensus odds on a recession next year have improved from 1 in 4 closer to 1 in 5. Most analysts don’t think we’ll get a recession next year. I think those odds should be closer to 50/50. Consensus forecasts for real GDP in 2012 are around 2%. I think that’s too high.
Last year, consensus was too optimistic. Consensus is now substantially more cautious, but I’m not sure they’re cautious enough.
2. That being said, I think the market could have a good year.
There isn’t a lot of correlation between the performance of the economy and the performance of the stock market. One lives completely in the present (the economy), while the stock market moves around based on what it sees in the future. If you’re trying to forecast the performance of the market this year, I sure hope you’re not looking at the current state of the economy. Any stock market forecast for 2012 is incomplete and without some sort of macro forecast for 2013+.
I think 2013 might be a year of better economic performance. That could be the year that the economy posts its best stimulus-free performance since before the crisis. As the market catches a whiff of that, it could rally at some point this year. Without spoiling some upcoming predictions, I think that real estate gains some traction this year and maybe even begins a slow psychology change as the value vultures get more active.
All of that could translate into legitimate economic improvement 12-18 months from now as homebuilders pick up the pace a bit and create some jobs — jobs that create other jobs too. Housing has always been a major component of GDP and it always will be as long as we have the awesomely powerful demographic tailwind of a steadily growing population. The entire real estate industry has appeared completely dead for years but at some point we’re all going to realize that it wasn’t dead, only asleep.
So this year could be the year when sensitive, forward looking things like the stock market start to smell that. That could then set the market up for a mini bear correction at some point in 2013, which would coincide perfectly with the 4-year presential cycle theory. The pattern doesn’t always hold, but on average, the first year of a president’s term tends to be the worst of the four for the stock market. The market also frequently bottoms right around the year of the midterm elections, so perhaps 2014 is the next really great buy point.
Finally, consensus forecasts have come so far in from last year that I think 2012 could be one where they finally nail the sentiment, but miss both the economic and market angles. I don’t think consensus is bearish enough on the economy and I think it’s too bearish about the market.
If that sounds like the craziest thing you’ve ever heard, make sure you’re on our weekly email list. Every week we talk about stuff that’s a little bit out there. In my experience, I’ve found that unconventional analysis and commentary adds the most value to the discussion. So that’s what I aim to deliver.
At some point in 2012, I wouldn’t be surprised at all to see the market look like a pretty attractive buy, at least on a short- or medium- term basis. I could even see myself getting quite bullish at some point in 2012.
To put a finer point on this prediction, I think the market ends the year higher, maybe even double digits, and I think the low comes in the first half of the year. With better economic hopes for 2013, some clarity about the election, evenascent EU headline risk, and retail holiday cheer, the last quarter or two of this year could make investors happy.
Put your opportunistic buy hat on for 2012. You don’t need to move now, but be ready. This could be a year where people who have the ability to tune out the noise of the headlines, act tactically, and stay focused at the legitimate fundamentals could reap some great rewards over the cycles of next couple of years.
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Click here for part two which features more predictions about gold, real estate, politics, and commodities!
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