by Cliff Wachtel, Global Markets and The Sensible Guide to Forex
Having reviewed the 2013 forecasts of at least most of the big names and institutions for the past weeks, here’s a distillation of what they say about:
- the array of bullish and bearish forces for 2013
- what will determine which side of these wins out
- the biggest questions and risks
We’ll add a few of our own conclusions and observations as needed.
Unless otherwise noted:
- We’re attempting to capture summarize the consensus view of 2013. When we offer our own thoughts, we’ll state explicitly that we’re speaking for ourselves.
- When we use the term risk assets we mean assets that rise with optimism and fall on pessimism about future growth. Safe haven assets perform in the opposite direction. Understanding the distinction between these two asset types and what drives them is fundamental and critical for understanding how, why, and when markets move as they do.
If you need to know more about this distinction, or other terms mentioned below, you can find much of what you’ll need in my book free of charge on its amazon page. Just place your mouse pointer on the Click to Look Inside feature, select the Table of Contents, and scroll down and click on these pages.
We all owe thanks to my editor Laura Walsh at Wiley & Sons for allowing a uniquely detailed table of contents to facilitate these kinds of searches.
ONE SENTENCE SUMMARY: ALL DEPENDS ON WHETHER STIMULUS KEEPS WORKING
We can expect more of the same as we saw in 2012 unless stimulus fails to prevent a contagion threat in the EU, US, other major economy.
We’re concerned about this view because:
- Stimulus is becoming less effective. In the US we’re already seeing diminishing returns from it. QE 1 saw the S&P 500 index rise almost 70%, and for QE 2, the index gained 23%. So far, since QE III was announced in September 2012, the S&P had lost 4% as of yearend (though has since erased that loss in the wake of the post fiscal cliff deal rally).
- If anything, it’s more likely that there will be less easing in 2013 and that will ultimately put a drag on risk asset prices. For example whatever the fiscal cliff and debt ceiling deal that ultimately happens; it will contain at least some austerity measures. For example, as Comstock Partners note here:
- The yearend deal still cuts GDP by ~1.5%, which is not insignificant given that the US is only growing about 2% per year.
- Moreover, the coming debt ceiling deal is likely to add additional austerity measures, and the uncertainty from what will likely be a bitter fight over it, should further pressure risk asset prices.
Here’s a bit more detail.
The S&P 500 index, as good an overall barometer of risk appetite versus risk aversion (aka optimism and pessimism) is widely expected to stay within about 14% of its 1426 close. Most expect a far smaller net result.
While the balance of fundamentals are negative, most expect a flat to mildly positive year for risk assets because they believe aggressive and massive government intervention to prop up asset prices with debt and money printing will continue to work for 2013. It’s understood that there will come a time when these supports need to be withdrawn. Meanwhile these policies can continue to support economies (in place of actual wealth creation and rising real incomes) as long as their primary dangers don’t outweigh their benefits. These dangers are:
- Inflation: Stagnant or falling real incomes and growth continue to keep inflation rates acceptably low
- Currency Debasement: Despite a ballooning Fed balance sheet (and even bigger balance sheet expansion by the ECB and Japan) we see no signs of a major loss of confidence in these or other overprinted currencies. These currencies fluctuate but remain within decade trading ranges versus other major currencies, demand for sovereign and corporate debt denominated in these remains good enough to prevent a bond market selloff that overwhelms central bank efforts and sends interest rates higher.
What to do? Income is getting emphasized over growth, given the very limited upside potential and likely essentially flat trading range of most risk assets.
Where we differ from the consensus:
- EU Crisis Risk Underestimated: We believe the most forecasts do not sufficiently price in EU crisis risk. That’s ok as long as you’re sure the past temporary solutions can continue to work. The US hasn’t been any better at taming its own debt issues, however these do not present as imminent or large a threat as the EU, where insolvency and breakup are real possibilities.
- Currency Diversification: Most 2013 forecast-related advice continues to underplay the risks of currency debasement implied by ongoing large scale monetary expansion. Just like you need to diversify by asset and sector class, so to you need to make sure your longer term portfolio is not too heavily exposed to the currencies at risk of debasement from aggressive printing and sovereign debt levels, like the USD, EUR, and JPY, among others. Our recently published book is all about a variety of ways to hedge this risk for both conservative traders and long term passive investors.
- We are reluctant to take new long positions given that risk assets remain high and the chances of a pullback of 10% or more are very good given the bearish forces covered above and in later parts of this 2013 outlook. Considering that most moderate risk assets produce 3-6% yields, the opportunity cost of waiting for that pullback is small compared to the gains of buying on the dips.
See here for an excellent piece by John Hussman how buying on the dips has become more important than ever since 2009, and also on the long term drag coming from the eventual rise in rates.
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