Predictions for 2013 By: Gabriel PotterMBA, AIFA® 2013.01.03

The base case

The end of the year is a time for reflection, and it is also a time to review predictions for the forthcoming new-year and update the base case assumptions.  Last year, the key issues impacting the market were driven by macroeconomic uncertainty.  This year, there is a greater argument for modest optimism, as there has been additional certainty, particularly in regards to the Eurozone.  The housing market, analyzed in our previous December 2012 newsletter, has been a drag over the past few years but is now projected to be a net gain to economic growth.  Individual households have successfully de-levered themselves from excess debt and are poised for healthy levels of consumption and savings.  Corporate America has weathered the storm with solid profitability and continuity, although margin expansion is expected to be lower this year.  There are still sobering problems of continued developed market indebtedness, but at least now the scale of the potential solutions match the scale of the problems in the Eurozone.  Still, the solid fundamentals must occasionally contend by national government ineptitude, both domestically and abroad.  For the United States, the already low-key growth projection will be necessarily muted by tax hikes and spending cuts inherent to the Fiscal Cliff compromise and the forthcoming debt ceiling negotiations.  Worse, the political climate may doom the US to a downgrade, no matter what actual numeric solution takes shape. The current Fiscal Cliff negotiation is not the last time Congress and the President will get to demonstrate their inability to work together; we are slated for additional debt ceiling talks very soon.  Furthermore, the Fiscal Cliff deal blocks spending cuts for 2 months, but that conversation has only been deferred.  Aside from the US, developed markets in the Eurozone are slated to have anemic growth due to austerity measures and weak growth, but – on the plus side – they have garnered more explicit commitment from the European Central bank and should have a bit more relative stability. Finally, emerging markets will likely continue as the highest sources of global growth, since their finances are not burdened with undue fiscal obligations, but their key problem is their continued need to focus towards domestic consumption, organic growth and political and market reform as opposed to a purely export driven model driven by cheap labor and commodity exports.

Government Policy:

Westminster Consulting is releasing a new magazine publication – Confero.  Within the cover article for Confero, readers will find an extended analysis of the likely impact of federal government policy towards the market.  At risk of being repetitive, Westminster regards the election as a validation of the status quo, particularly in regards to financial regulation and the health care legislation. 

Interest Rates & Inflation:

The threat of deflation is probably lower now than it has ever been following the 2008 crisis because developed monetary institutions have made nearly explicit promises to attack liquidity issues by printing money.  Specifically, European Monetary Board leader Mario Draghi promised to do “whatever it takes” to maintain the Euro, and the promise includes the implication that the European Central Bank will simply print money to pay off nominal debt from strained national borrowers (like Greece).  Essentially, the ECB has decided to monetize its debt problem and it will not risk short term insolvency to deal with their structural problems.  Furthermore, the United States Federal Reserve announced continuing expansion of its balance sheet (QE3) and nearly explicit promises to keep rates low.  Furthermore, the November election affirms a continued accommodative monetary policy.   

Market Targets:

As December marches forward, more information over key predications of economic health – specifically, GDP forecasts and S&P market target values - are becoming available.  Here is a sampling of US Gross Domestic Product Estimates and year end S&P targets for 2013.

 

Institution

S&P Market End Target for 2013

Ending Value, Dec 31 2012

1426

Credit Suisse

1550

Federated Investors

1660

Barclay's Capital

1525

Putnam Investments

1490

BlackRock

1545

Goldman Sachs

1575

JP Morgan

1580

Citigroup

1615

Morgan Stanley

1434

Prudential

1600

Bank of America / Merrill Lynch

1600

Growth:

In short, there is relative optimism about the market despite a consensus of generally tepid growth and an end to the accelerated advance of corporate profits.  Earnings are not going to improve at the same pace as the previous two years, but few analysts call for an outright recession in the United States, although many call for a near recession in European economies.  The rosy market targets in the previous section reflects easing on those factors that are holding back investor enthusiasm – a valuation problem – rather than any tremendous catalyst for explosive global or domestic growth.

Here is a sampling of US Gross Domestic Product Estimates and year end S&P targets for 2013.

 

Institution

US GDP Growth Estimate for 2013

Current

~2% for 2012

Federal Open Market Committee

2.5% - 3.0%

National Association for Business Economics

2.4%

Chicago Fed Economic Outlook Symposium

2.3%

Barron’s Economist Poll (average of 10)

1.9%

International Monetary Fund

2.1%

Our favorite prediction systems for 2013

Basic economic models are usually based on perfect information, among completely rational actors with purely quantitative goals.  Modern finance is predicated on rational behavior.  Large scale macroeconomic calls made by market strategists presume that the aggregation of consumer and investor behavior follows predictable paths. 

The real world doesn’t always work like that.   (If it did, analysis of the markets would be a rote exercise.)  There are always irrational actors, unforeseen events, and a healthy dose of chaos - inherent to any sufficiently complex system - to keep the results interesting. 

To provide a counterpoint to the consensus of modest gains in the stock market based on fundamental data, we would like to present several fun alternative methods for determining the direction of the markets.  Readers of our previous blogs and articles will know that we have referenced other frivolous market predicators, such as the “Price in Butter in Bangladesh” Theory, in an attempt to show how coincidence and correlation within patterns can be mistaken for causation.  With the caveat these indicators are presented primarily for amusement, here are some of our favorite stock market indicators from Investopedia.com:

Prediction Model 1 – The Super Bowl Indicator

This indicator asserts a Super Bowl win for a team from the AFC division foretells a decline in the stock market for the coming year, and a win for a team from the NFC division means the stock market will be up for the year.  Despite being spectacularly wrong regarding the 2008 market crash, the Super Bowl indicator still boasts an 80% accuracy rate.

Prediction Model 2 – The Leading Lipstick Indicator

An indicator based on the theory that a consumer turns to less expensive indulgences, such as lipstick, when she (or he) feels less than confident about the future. Therefore, lipstick sales tend to increase during times of economic uncertainty or a recession. This term was coined by Leonard Lauder (chairman of Estee Lauder), who consistently found that during tough economic times, his lipstick sales went up. For example, in the months following the September 11 terrorist attacks, lipstick sales doubled.

Prediction Model 3 – The Men’s Underwear Index

An unconventional measure of how well the economy is doing based on sales of men's underwear. The reasoning behind this measure assumes that men view underwear as a necessity (not a luxury item), so sales of this product should be steady - except during severe economic downturns, when men will wait longer to buy new underwear. The notable decrease in underwear sales is said to reflect the poor overall state of the economy. Conversely, when underwear sales pick up, the economy is considered to be improving.

Happy New Year to all.  We wish you all a prosperous new year.

 

 

Gabriel Potter

Gabriel is a Senior Investment Research Associate at Westminster Consulting, where he is responsible for designing strategic asset allocations and conducts proprietary market research.

An avid writer, Gabriel manages the firm’s blog and has been published in the Journal of Compensation and Benefits,...

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