Swedroe: ‘Sure Thing’ Predictions Batting Zero

October 12, 2016

Every January, I compile a list of predictions that financial “gurus” have made for the upcoming year, especially the ones that gain consensus in the media or those that I frequently hear referred to among investors as “sure things.” I then keep track of whether these “sure thing” forecasts have actually come to pass through a series of periodic updates.

The turn of the calendar into October means that it’s time for our third-quarter review. As is our practice, we’ll give a score of +1 for a prediction that came true, a score of -1 for one that was wrong, and a score of 0 for one that was basically a tie.

Fed-Related Predictions Miss The Mark

Our first sure thing was that the Federal Reserve will continue to raise interest rates in 2016. That frequently leads to the recommendation that investors limit bond holdings to only the shortest of maturities. At its September meeting, the Fed left the target range for its federal funds rate unchanged at 0.25% to 0.5% for the sixth time. In addition, the Vanguard Short-Term Bond Index ETF (BSV) returned 2.6% and the firm’s Intermediate-Term Bond Index ETF (BIV) returned 7.2%, while its Long-Term Bond Index ETF (BLV) returned 16.1%. Score: -1.

The second sure thing was that economic growth, while remaining relatively tepid, will improve. The Federal Reserve Bank of Philadelphia’s fourth quarter 2015 Survey of Professional Forecasters predicted unremarkable real GDP growth of 2.6% in 2016, a bump up from the final forecast of 2.4% in real GDP growth for 2015. Thus, a low bar was set for growth to improve. But at its September meeting, the Federal Open Market Committee lowered its GDP growth forecasts for 2016 to just 1.8% from 2% in the June projection. Score: -1.

Our third sure thing followed from the first two. With the Fed’s tightening and the economy improving—combined with the economies of European and other developed nations still struggling to generate growth, and with their central banks engaged in very easy monetary policies—the dollar would strengthen. The dollar index (DXY) ended last year at 98.69. The dollar index ended the third quarter of 2016 at 95.42. Score: -1.

Stocks Mostly Defy Expectations
The fourth sure thing was that with the cyclically adjusted price-to-earnings ratio at roughly 25.9 as we began the year, almost 60% above its long-term average, U.S. stocks are overvalued and thus should be avoided in 2016. Through the third quarter’s end, Vanguard’s (U.S.) Total Stock Market Index ETF (VTI) returned 9.1%, outperforming its Total International Stock Index ETF (VXUS), which returned 6.7%, as well as all but long-term bonds. Score: -1.

The fifth sure thing was that, given relative valuations, U.S. small-cap stocks will underperform U.S. large-cap stocks. Morningstar data showed us that, near the end of 2015, the price-to-earnings (P/E) ratio of Vanguard’s Small Cap Index ETF (VB) stood at about 20.6, while the P/E of the Vanguard 500 Index Fund (VOO) stood at roughly 18.5. Through the end of the third quarter, VB returned 11.4%, outperforming VOO, which returned 7.7%. Score: -1.

 

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