Swedroe: ‘Sure Things’ Check-In

October 16, 2017

At the start of 2017, I compiled a list of predictions that gurus had made for the upcoming year, along with some items that I hear frequently from investors, for a sort of consensus on the year’s “sure things.” I’ve kept track of these sure things with a review at the end of each quarter.

With the turn of the calendar, our third quarter review of 2017’s list is due. As is my practice, I’ll 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.

Bonds & Stimulus
Our first sure thing was that the Federal Reserve would continue to raise interest rates in 2017, leading many to recommend investors limit their bond holdings to the shortest maturities. Economist Jeremy Siegel at one point even warned that bonds were “dangerous.” And on March 15, 2017, the Federal Reserve did raise interest rates by 0.25%. It did so again on June 14, 2017.

However, despite the prediction that interest rates would rise having actually come to pass, through Sept. 30, 2017, the Vanguard Long-Term Bond ETF (BLV) returned 7.8%, outperforming the Vanguard Short-Term Bond ETF (BSV), which returned 1.5%, and the Vanguard Intermediate-Term Bond ETF (BIV), which returned 3.8%. Score: -1.

The second sure thing was that, with the large amount fiscal and monetary stimulus we have experienced, in addition to the anticipation of a large infrastructure spending program, the inflation rate would rise significantly. On September 14, 2017, the Bureau of Labor Statistics reported that in August the Consumer Price Index for All Urban Consumers (CPI-U) increased 0.4% on a seasonally adjusted basis. The agency also reported that the index for all items rose just 1.9% over the last 12 months. The index for all items less food and energy had risen just 1.7% over the 12 months prior to that. Score: -1.

The third sure thing was that with the aforementioned stimulus, anticipated tax cuts and a reduction in regulatory burdens, the growth rate of real GDP would improve from its 1.6% growth in 2016 to 2.2% this year. But first quarter growth was just 1.2%. The second quarter came in better at 3.1%. The current full-year forecast from the Philadelphia Federal Reserve’s Survey of Professional Economists is for growth of 2.1%. We’ll give this a score of +1.

Our fourth sure thing follows from the first two. With the Fed tightening monetary policy and our economy improving—and with the economies of European and other developed nations still struggling to generate growth, and with their central banks still pursuing very easy monetary policies—the dollar would strengthen. The dollar index (DXY) ended 2016 at 102.38. The index closed the third quarter at 92.88. Score: -1.

Emerging Markets & Valuations
The fifth sure thing was that, with concern mounting over the potential for trade wars, investors should avoid emerging markets. Through September 30, 2017, the Vanguard Emerging Markets Stock ETF (VWO) returned 23.6%, outperforming the Vanguard 500 ETF (VOO), which returned 14.2%. Score: -1.

The sixth sure thing was that, with the Shiller cyclically adjusted price-to-earnings (CAPE) ratio at 27.7 as we entered the year (66% above its long-term average), domestic stocks are overvalued. Compounding the issue with valuations is that rising interest rates make bonds more competitive with stocks. Thus, U.S. stocks would be likely to have mediocre returns in 2017. A group of 15 Wall Street strategists expects the S&P 500, on average, to close the year at 2,356. That’s good for a total return of about 7%. As noted above, VOO already has returned 14.2% in just the first nine months of the year. Score: -1.

The seventh sure thing was that, given their relative valuations, U.S. small-cap stocks would underperform U.S. large-cap stocks this year. Morningstar data showed that, at the end of 2016, the prospective price-to-earnings (P/E) ratio of the Vanguard Small Cap ETF (VB) stood at 21.4 while VOO’s P/E ratio stood at 19.4. Through September 30, 2017, VB returned 10.6%, underperforming VOO, which, as we stated, returned 14.2%. Score: +1.

The eighth sure thing was that, with non-U.S. developed market and emerging market economies generally growing at a slower pace than the U.S. economy (and with many emerging markets hurt by weak commodity prices, slower growth in China’s economy, the Fed tightening monetary policy and a rising dollar), international developed market stocks would underperform U.S. stocks in 2017. Through September 30, 2017, the Vanguard Developed Markets ETF (VEA) returned 21.0%, outperforming VOO. Score: -1.

Our final tally for the period shows that six “sure things” failed to occur while just two happened. I’ll report back again at the end of the fourth quarter for a full-year accounting. The following table shows the historical record since I began this series in 2010.

 

Year Number of Sure Things Yes/True (+) No/False (-) Tie/Draw
2017 Q3 8 2 6 0
2016 8 2 6 0
2015 8 3 4 1
2014 10 3 7 0
2013 7 2 5 0
2012 8 3 4 1
2011 8 1 7 0
2010 5 1 4 0
Total 62 17 43 2

 

The table shows that only a little more than 25 percent of “sure things” actually came to pass. Keep these results in mind the next time you hear some guru’s forecast.

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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