Swedroe: What The Experts Got Right In 2016

January 30, 2017

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 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 a brand-new year means it’s time for our final review of 2016’s list. 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.

Interest Rates, GDP And More
Our first sure thing was that the Federal Reserve would continue to raise interest rates in 2016. That frequently leads to the recommendation that investors should limit bond holdings to only the shortest of maturities. At its December meeting, the Fed finally raised the target range for its federal funds rate to 0.50-0.75%, its first increase of the year. Vanguard’s Short-Term Bond Index Fund (VBIRX) returned 1.5% last year and its Intermediate-Term Bond Index Fund (VBILX) returned 2.8%, while the firm’s Long-Term Bond Index Fund (VBLIX) returned 6.6%. Score: -1.

The second sure thing was that U.S. economic growth in 2016, while remaining relatively tepid, would at least match the 2.6% growth rate of 2015. While we don’t yet have the final GDP figure, in a December announcement, the Federal Reserve Open Market Committee put its full-year forecast of GDP growth at just 1.9%. 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 2015 at 98.69. The dollar index ended 2016 at 102.38, an increase of 3.7%. Score: +1.

The fourth sure thing was that with the cyclically adjusted price-to-earnings (CAPE) ratio at about 25.9 as we began 2016, almost 60% above its long-term average, U.S. stocks were overvalued and should be avoided. Vanguard’s (U.S.) Total Stock Market Index Fund (VTSAX) returned 12.7% last year, outperforming Vanguard’s Total International Stock Index Fund (VTIAX), which returned 4.7%, as well as the three Vanguard bond funds mentioned previously. Score: -1.

 

From Small Caps To Annual Returns

The fifth sure thing was that given their relative valuations, U.S. small-cap stocks would underperform U.S. large-cap stocks. Morningstar data showed that as we approached the end of 2016, the price-to-earnings (P/E) ratio of Vanguard’s Small Cap Index Fund (VSMAX) stood at about 20.6, while the P/E ratio of the Vanguard 500 Index Fund (VFIAX) stood at roughly 18.5. VFIAX returned 11.9%, while VSMAX returned 18.3%, outperforming it by 6.4 percentage points. Score: -1.

The sixth sure thing was that with the non-U.S. developed and emerging market economies generally growing at a much slower pace than the U.S. economy (and with many emerging markets hurt by falling commodity prices, slower growth in the Chinese economy, the Fed tightening monetary policy and a rising dollar) international stocks would underperform U.S. equities in 2016. The Vanguard (U.S.) Total Stock Market Index Fund (VTSAX), which returned 12.7%, outperformed both Vanguard’s Developed Markets Index Fund (VTMGX), which returned 2.5%, and Vanguard’s Emerging Markets Stock Index Fund (VEMAX), which returned 11.7%, last year. Score: +1.

The seventh sure thing was that, after defying the gurus in 2015, the volatility of the market would rise in 2016. The VIX ended 2015 at 18.2. Following a tumultuous start to this year, since early March (with the exception of a brief period following the Brexit vote), market volatility was relatively quiet. The VIX ended 2016 at just 14.0. Also showing the market was less volatile, in 2016, the number of days in which the S&P 500 changed value by more than 1% fell from 72 (29% of the trading days) in 2015 to 48 (19% of the trading days) in 2016, and the number of days in which it changed value by more than 2% dropped from 10 to nine. Finally, annualized volatility came in at 13.1%, which ranks in the 47th percentile over rolling periods since 1929. That seems pretty normal. Score: -1.

Going back to 1896, the first three quarters of the last year of the presidential cycle have all produced below-average returns, although the fourth quarter of that year has produced above-average (almost 5%) returns. Thus, our eighth sure thing was that the first nine months of 2016 would be disappointing, but we would be bailed out by strong performance in the fourth quarter. Through September, the S&P 500 returned 7.8%, an annualized return of 10.6%. That’s right in line with its historical compound return. The index finished up 12.0% for the full year. Score: -1.

 

Adding It Up
Our final tally shows that just two of these eight sure things actually occurred. Keep in mind that if these predictions were truly “sure things,” most, if not all, should have happened.

This was the seventh year I’ve been keeping track of sure-thing predictions and consensus expectations among investors. The following table provides the outcomes for each year, as well as the total score for the full period.

Out of 54 sure things, just 15, or 28%, actually occurred. Just another example of why you should ignore all forecasts, no matter how prescient they sound, and why so much of stocks and bond returns are explained by surprises.

As a final note, we could have certainly added to our list of “sure things” that wouldn’t happen in 2016 Donald Trump’s nomination by the Republican party; if nominated, his election to the presidency; and if elected, that the uncertainty caused by his victory would lead to a bear market. Three strikes and you’re out.

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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