In the blink of an eye Christmas will be here and then New Year’s. We’re on the doorstep of 2013. Where did the year go?
I want to spend the next two weeks recapping not just our predictions but what happened this year and which trends and ideas dominated the marketplace. This annual exercise is not about saying “here’s what I got right and here’s why I’m AWESOME!” It’s about thoughtfully reflecting on what we got right or wrong, and more importantly, why we got it right or wrong.
What lessons did we learn? What lessons didn’t we learn?
Let’s get straight to it.
2012 in Review
At the beginning of the year I outlined 4 major factors that I thought would shape the action of both the economy and the market (our first lesson is that those aren’t always the same).
- The Election
- The U.S. Consumer
In retrospect, those were indeed the right issues to watch. But those were also fairly easy to see coming. What matters is how you use them and the way that you interpret the possibilities.
I was of the belief that Europe would see no resolution of its fundamental problems but quietly fade from the headlines. I’m not sure that’s totally been the case. There are still plenty of headlines swirling out of Europe, the latest involving Italy. Europe remains a risk for the market and investors are still plenty concerned about it. Greece is a problematic as ever. They’re still rioting. Spain is a disaster with unbelievable unemployment. Italy’s as hot a mess as ever. Even the German economy slowed down!
Despite all that, the market doesn’t really seem to care today. It seems to have become somewhat inured to Europe’s dysfunction. This, of course, is incredibly dangerous and something to watch closely in 2013. Perhaps Europe has some ugly surprises in store for us yet.
A presidential election is obviously a big event for the market, but this year I felt like it was extra-big. This was the year where whoever emerged as the winner was going to be tasked with shaping a very new trajectory for policy, the side effect which would be a contentious, winner-take-all political environment where nothing would get done. This was 100% correct and actually proved quite useful. I couldn’t have manufactured a better case-in-point than the way in which the fiscal cliff is being handled right now. Anybody who was betting on a bit of policy uncertainty to go away in 2012 was disappointed.
Politics played a huge role in the markets in 2012, just as it did last year when a mechanical act like simply raising the debt ceiling somehow generated over-the-top political debate. For what it’s worth, once the fiscal cliff is resolved — and I believe it will be — that’ll be the end of the Political Effect in the markets. At least for a while. It’s still very early and I want to incorporate it in my predictions for next year, but I think this was the year that a new trajectory in politics was born.
I know that’s a very controversial, variant call. But I think 2012 represented Peak Partisanship. In retrospect, this election & fiscal cliff bargaining will appear to have been the bottom.
The U.S. consumer was certainly weak this year. Right now he’s the single biggest drag on economic growth. And he’s dragging because he’s still de-leveraging and his income is slowly, steadily falling. Through the first 3 quarters, growth in personal consumption expenditures are running less than they did last year, 1.39% vs. 1.26%. That being said, consumption hasn’t lagged as much as I thought. Q4 is usually a strong quarter for consumption, so there’s still a chance the year as a whole may top 2011.
While the consumer is definitely hurting, I thought that with all the uncertainty swirling out of Europe and around the election the consumer would take a breather and actively re-trench in 2012. He didn’t, really. All the uncertainty did was keep him from growing his consumption. Perhaps, during relatively “normal” times, that’s the most that uncertainty can do: keep him fixated on just preserving the status quo. Shame on me for betting against him.
The only thing with the power to officially KO the U.S. Consumer is a financial crisis or obvious recession. This was a very important lesson learned in 2012. So when you do eventually see the personal consumption component of GDP fall to zero or contract, take note, because that’ll be the first clear mile-marker in the next recession.
Finally, this was a huge year for China. It was a big year politically with a change in leadership from Hu Jintao to Xi Jinping, as well as scandal in the case of Bo Xilai. 2012 was yet another reminder of complicated nature of China’s economy and the role they’ll play going forward. Growth over there slowed to its lowest level since 2009, clocking in 2.5% below its 30-year average of 10%/year. Wow.
Avoiding Chinese stocks probably saved you a lot of money as the Shanghai Composite trended straight down all year. It hasn’t been a pretty stretch for the Chinese market since the post-crash bounce of 2009. This year investors grew even more skeptical about whether China can be successful in reshaping into its economy into something that is based less on cheap manufacturing and more on internal consumption.
The traditional ” East Asian Economic Model” — first seen in post-war Japan, then Taiwan, and then Korea — has run its course in China. Other Asian economies like Malyasia, Indonesia, and The Philippines have picked up that slack. Those have been and will probably continue to be great places to be invested, too, before that model inevitably runs its course in those locales as well. These countries aren’t stupid and they understand the path to wealth (in the short run) lies in their comparative advantage of cheap labor and a global demand for manufactured goods.
Will China successfully adopt a more sustainable long-term model for economic growth? I have no idea. But 2012 was certainly the year where that debate picked up steam. The world is looking at China through a substantially more realistic lens.
For the most part, the macro backdrop in 2012 was fairly easy to predict. Very little this year surprised me and there weren’t any “Black Swans” of significance.
With that, let’s now run through the first five of our specific predictions, which were a little more bold than sketching out the simple backdrop.
1. The economy enters recession (or close enough to it) – WRONG!
Again, we’ll wait and see how 4th quarter data comes in but I’m certainly not holding my breath. The NBER will not be calling a recession in 2012. This was a decisively non-mainstream call, with consensus assigning only about a 20% probability of recession. I thought the odds should have been closer to 50/50 given that big backdrop of uncertain outcomes.
My specific forecast was that the economy would be the weakest since the crisis, stalling out between 0% and 1.5% if not slipping into negative territory. Even that was incorrect. I know the data wasn’t far enough off to panic about but I really feel like I missed this call by more than that’s letting on. I was really thinking that this would be a very concerning year for the economy and that more analysts would come into the recession camp as the year went on.
None of that happened. The U.S. consumer may have bent slightly but didn’t come close to breaking. He did OK.
LESSON: Be careful betting against the U.S. consumer and have faith in the Fed’s ability to do crazy things to keep the economy from falling apart. You’d think I would have learned that lesson in previous years. Nope. And it’s possible I still haven’t totally learned this lesson, either.
2. The market has a good year - CORRECT!
Through this writing the market is up around 14%. We’ve still got a few weeks to go, but that definitely qualifies as a good year.
I feel really good about this one because consensus was very bearish on the market at the beginning of the year, no surprise after a dismal and volatile second half of 2011. My basic view at the beginning of this year was that consensus wasn’t bearish enough on the economy but too bearish on the market. I only got the latter half of that paradoxical prediction correct.
I also wrote at the beginning of the year that “I could even see myself getting quite bullish at some point in 2012.” Perhaps that was something of a self-fulfilling prophecy, but after the correction in May I got about as bullish as I ever get on the broad market. I even wrote about it. The single best call I made at any point in the year was betting against consensus sentiment in the middle of the year. The market rallied nearly 15% between June and September.
LESSON: it’s one thing to be a general contrarian, but it’s probably best to only act on that contrarian instinct when things get extreme. Don’t be afraid to do it, either. Once again the adage to “buy when others are fearful” proved correct. Buying when others are fearful is a move with a much more favorable risk/reward distribution than you’d think.
3. The great gold run is over – CORRECT (with caveats)
I really think this one depends on how you see the world. The long term trend in gold is still sufficiently big and powerful that you could put up a 10yr chart on gold and still successfully argue that the trend is intact.
But check out a 3yr chart of gold:
That chart is not subject to creative interpretation. The data clearly indicate a failure of the medium-term bull trend. For an annual forecast, that’s good enough for me. And I wasn’t looking for gold totally fall apart, just to see some hard evidence to suggest the perennial ascension is over with.
Since cresting at over $1900/oz, gold has failed not once, not twice, but three times to break through 1800. When Wall Street 2013 forecasts start to trickle in during the next few weeks, expect to hear a large number of them contain “range bound” forecasts for gold. That’s because gold is now officially stuck in a range and analysts make forecasts by extrapolating current trends indefinitely into the future.
It’s over, folks. Sorry. What happens between now and 2020 will look very different than what happened between 2004 and 2012.
Although, if it breaks decisively above 1800 in the next few months, I will gladly issue a mea culpa and take this one off the board. I still do own some physical gold myself, mind you. I still hope to see its value increase in the coming years, but I’m not willing to stake any more than 5% of my investment net worth on that proposition.
LESSON: Gold is simply a price, elegantly defined by Jim Grant as  divided by the [the world's faith in Ben S. Bernanke and the like]. Gold is also religion: you either believe or you don’t believe. This makes it dangerous. But it’s truly different and because of this every investor needs to own a little bit. The fundamentals of gold are important, and may be the ultimate driver of price, but they are so complicated and nuanced that most investors can’t interpret them properly. One simply must have an understanding of technical analysis when assessing gold. Edwards’ & Magee’s Technical Analysis of Stock Trends is a good place to start.
Technical evidence aside, the reason why I’m inclined to give myself a CORRECT on this one and not a WRONG is that I feel like faith in central bankers, particularly European central bankers like Draghi, is increasing. At the very least, we certainly didn’t lose more faith in our central bankers in 2012 nor did the gold price decisively suggest that we did.
4. China slows down bigtime – CORRECT!
Boy, did China slow down. As I mentioned at the top, this was the worst year for China in a while.
GDP ”GDP”, was around 7.5% through the first three quarters. Coincidentally, their target for 2012 was… wait for it… 7.5%!
Here’s a 5yr chart of the Shanghai Composite:
Anybody out there believe that China is still the hot emerging market for growth? If so, it’s time to stop living in 2006 and join the rest of us in 2012. Hold on. On second thought, if you’re still living in 2006 you may as well stay there. No sense ruining your fun!
All joking aside, at some point it’s going to make sense to get a little bullish on China. Their market is due for a good year eventually and it’ll happen exactly when the world least expects it. The problem is that, as I’ve written numerous times, their economy faces serious structural challenges. Perhaps they’ll meet those challenges — Steve Roach certainly thinks so — but the market disagrees right now.
China’s economy — like its beautiful and fascinating culture — is a tangled nest of contradictions. On the one hand, post-bubble, their economy is more of a known quantity. But by the same token, it still suffers from manipulation and obfuscation, far more than one would think possible in an economy of that size. There is potential for massive macroeconomic benefit as their economy switches gears and modernizes, yet they are on the doorstep of gigantic demographic challenges as their population starts shrinking before a certain collapse towards the middle decades of this century. Finally, most economies would kill for 7% growth but in China that qualifies as abject failure. It’s an interesting place.
Going forward, China is going to be a tricky bugger to forecast. This’ll probably be the last year I try.
LESSON: A lot of people are going to make a lot of money in China in the coming decade. But they’re going to do it by identifying single companies that play into the trends of the moment and successfully straddle the line between government control and capitalistic freedom.
There’s also money to be made by shorting companies that are frauds, because their market is going to see a lot of fraudulent companies given a less-developed legal infrastructure. Being a successful investor in China will involve a highly skill-based, localized approach. If that’s you, giddyup. If you’re sitting at home in your pajamas and an E*Trade account (like me), then there are still better, broader economies to bet on.
5. Real estate bottoms. Housing starts to heal – CORRECT!
There is a legitimate recovery in housing underway. We’re in the early innings of a game progressing towards historical normalcy. The data certainly doesn’t suggest that we’re growing gangbusters, but the trend is firmly, officially up. Across the board from prices to activity to stock performance. Every metric of real estate improved in 2012 and most outpaced expectations. This is one of the few bright spots in the economy right now, a nice change of pace after being the millstone around or economic neck for so many years.
LESSON: New home starts has proven to be one of the most important data points to watch. It correlates with all sorts of good economic stuff, including job growth. Also, real estate this year was a great reminder that data trumps psychology, especially over longer windows of time. Forward-looking data points like homebuilder stocks and residential investment GDP data were starting to gather steam near the end of last year despite a persistently awful national psychology in real estate. Betting on the data instead of conventional wisdom was a smart move in 2012.
That’ll do it for now. Stay tuned next week for our thrilling recap!