Swedroe: Gurus Had A Strong Half

July 09, 2018

At the start of 2018, I compiled a list of predictions that gurus had made for the upcoming year, along with some items that I heard frequently from investors, for a sort of consensus on the year’s “sure things.” The turn of the calendar means it is now time for our midyear review. As is my practice, I will give a score of +1 for a forecast that came true, a score of -1 for one that was wrong, and a 0 for one that was basically a tie.

Our first sure thing was that the U.S. economy would grow faster, with GDP growth forecasted at 2.5% for 2018. GDP increased at just a 2.0% annual rate in the period January through March. However, GDP growth in the second quarter is estimated to be at a much higher pace. For example, the latest estimate from the Federal Reserve Bank of Atlanta is for second-quarter GDP growth of 4.1%. And the Federal Reserve Bank of Philadelphia’s second-quarter Survey of Professional Forecasters has a full-year GDP growth forecast of 2.8%. Of course, with threats of a full-scale trade war looming, the outlook remains cloudy. I’ll score this one a 0.

Our second sure thing was that, given the expected fiscal stimulus from the Tax Cuts and Jobs Act of 2017, along with expectations for not only stronger economic growth but tighter labor markets, the Federal Reserve would continue to raise interest rates in 2018. Markets began the year expecting three rate hikes. That leads to the recommendation that investors should limit their bond holdings to the shortest maturities. The Fed has raised rates twice so far in 2018 and a third is still expected. The recommendation to stay short has been correct. The Vanguard Long-Term Treasury Index ETF (VGLT) returned -3.1% through the first six months of 2018, underperforming the Vanguard Intermediate-Term Treasury Index ETF (VGIT), which returned -1.2% over that same period. The Vanguard Short-Term Treasury Index ETF (VGSH) outperformed both, returning 0.0% through June. Score: +1.

Our third sure thing was that tightening labor markets, stable and broader global growth, and a nadir in commodity prices would cause inflation to rise from cyclical lows. This, of course, ties into the second sure thing about rising rates and the recommendation to avoid term risk. The Consumer Price Index (CPI) increased 2.1% in 2017. There has not been any significant jump in the rate of CPI change, with the first five months of 2018 showing changes of 0.5%, 0.2%, -0.1%, 0.2% and 0.2%, respectively. Score: -1.

Strengthening Economy

Our fourth sure thing was that, with help from tax cuts, the U.S. economy would pick up steam and corporate earnings would get a big boost. That leads to the recommendation that U.S. stocks are the place to be, outperforming international stocks. Through June, the Vanguard Russell 3000 ETF (VTHR) returned 3.2%, outperforming the Vanguard FTSE Developed Markets ETF (VEA), which returned -2.8% and the Vanguard FTSE Emerging Markets ETF (VWO), which returned -7.3%. Score: +1.

Our fifth sure thing follows from the fourth. With a strengthening U.S. economy and new tax cuts encouraging U.S. multinationals to repatriate earnings, the U.S. dollar would strengthen. The dollar index (DXY) ended 2017 at 92.1, and closed the first half of 2018 at 94.5. Score: +1.

Our sixth sure thing was that stock market volatility would rise this year (which could test investor discipline). I’d note it’s hard to disagree with this one, as we began 2018 with the VIX at a record low of roughly 9. The VIX closed the first half of the year at about 16. Score: +1.

Our seventh sure thing was that with U.S. stock valuations high, the place to be is in defensive funds, such as the iShares Edge MSCI U.S.A. Quality Factor ETF (QUAL) or the Invesco Defensive Equity ETF (DEF). As previously noted, the Vanguard Russell 3000 ETF, VTHR, returned 3.2% over the first half of 2018, outperforming both QUAL, which returned 1.6%, and DEF, which returned -0.1%. Score: -1.

Our midyear 2018 score comes to four winners and two losers, with one draw. As the following table shows, if that rate holds up for the rest of the year, it will be the first time I’ve ended the year with a positive score.

 

 

I’ll again report back on the status of these “sure thing” predictions at the end of the third quarter.

Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.

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