At the end of the year, it is a hobby of many (myself included) to go back and look at the awful predictions made at the end of 2011 regarding what would occur in 2012. However, I want to be a hypocrite and make a forecast for 2013.
I was asked to take part in a survey of 42 ‘select’ people in the financial industry regarding what level the Standard & Poor’s 500 would be trading at in one year. I think it is close to impossible to predict this, but the S&P 500 is currently trading at 1,420, and I think we could see a 10 percent decline, so I stated 1,285. Afterward, I noticed that almost every single person predicted the S&P 500 would rise in 2013. The people surveyed have all different strategies and many of them are far smarter than me; however, the trend was a bit disconcerting.
The consensus is usually wrong and 2013 should be no different. The reason I originally predicted the decline was several fold. First, let us look at some numbers for recent S&P 500 returns. In 2009, the S&P 500 was 26.46 percent, 2010 15.06 percent, 2011 2.05 percent and in 2012 the return is approximately 15.2 percent. The stock market on average returns 8 to 10 percent a year, and stock market returns have been far above average, excluding 2011. This does not mean the market will decline in 2013, but eventually what goes up most go down.
An even more important factor is market valuations. A common metric is the Shiller price-earnings ratio. The metric divides the S&P 500 by the past 10 years of earnings (adjusted for inflation). The higher the number, the more likely the market is overvalued. Right now, the United States has the fourth highest Shiller PE, at 21. Additionally, the median is about 15.85, which would mean the stock market would need to drop almost 30 percent to become fairly valued.
Further, the profits for companies are inflated, which means the Shiller PE should be far higher. Corporate profit margins are at an all-time high and close to double the long-term average. Companies have been squeezing out every extra bit of income by working employees harder and cutting expenses. However, this cannot last forever, and when profit margins come down so will earnings, which will push up the Shiller PE even if the S&P 500 stays flat.
Finally, Morgan Stanley recently came out with a shocking study. Ten companies have contributed to 88 percent of earnings growth for the S&P 500. Six of these companies are financials, which tend to have very volatile earnings. A noteworthy name on the list is Apple. If Apple has bad earnings and banks have a bad year, where will the money come from?
Based on some of the factors above, investors should be fearful going into 2013 (and we have not even discussed the frightening macro picture). The world did not end in 2012 as the Mayans predicted, and likely will not end in 2013, but caution is warranted.
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