Men work on an oil well pump near Sweetwater, Texas on Dec. 23, 2014.LM Otero/The Associated Press
David Rosenberg, a guest columnist for Inside the Market, is chief economist and strategist at Gluskin Sheff & Associates Inc.
Do I feel lucky? Well, do ya, punk?
This blog post is less about Dirty Harry and more about whether it is to be lucky or good when it comes to forecasting.
For instance, in the mid-December issue of Barron's back in 2013, there were 10 well-known and respected Wall Street strategists who made up the newspaper's forecasting group for 2014. The consensus call was not really that far off the mark as far as the S&P 500 target is concerned even if a tad light at 1,977 (it closed 2014 at 2,058) as much as in the sector recommendations.
Out of these 10 market seers, only one said to avoid Energy, by far the worst performing equity sector with a 10 per cent loss. At the same time, eight of the 10 advised against owning Utilities even though this was the best sector with a 24.3 per cent run up in 2014 – only one slapped a buy recommendation on this group.
The same pretty well holds true for Health Care which came in second spot with a 23.3 per cent gain last year – yet only two of the 10 strategists told the investing public that they were worthy of owning.
Eight also recommended not being exposed to the U.S. Consumer groups and yet Staples rose nearly 13 per cent last year and Discretionary turned in an 8 per cent+ gain.
This is not an exercise in picking on forecasters (especially since I happen to be one myself) but sometimes it comes down to being lucky as opposed to being good. There were probably an array of fundamental factors at play that caused these strategists to miss out on the Utilities sector, and that boils down to the view that bond yields had nowhere to go but up – and Treasury rates went down quite a bit as we all know.
Perhaps the advent of Obamacare caused too much uncertainty over the outlook for Health Care and virtually nobody saw the oil price collapsing as it did in the second half of the year, as much a Black Swan event as the 2008/09 global financial collapse. Few if any considered that job creation in 2014 would look a lot like 1999 so the consumer performance was generally under-rated this time last year.
What about this year? Well, the latest Barron's forecast shows that of the 10 prognosticators, only three are bullish of Energy (though only one said to avoid the sector altogether – call it a combination of uncertainty over where the oil price goes from here and just general ambivalence towards the sector). Yet this could be the real sleeper for 2015.
Within the TSX, for example, Energy has been so beaten up that it has declined in three of the past four years and underperformed the broad market in four of the past five and seven of the past nine.
I am not sure that this is well understood – the news may be bad but it seems to be priced in and perhaps a bit more than that (for investors who seek success by buying what is out of favour).
Within the S&P 500, the Energy sector was down 10 per cent in 2014, in the top five worst years for this space since 1982. There have been times in the past when Energy stocks declined in a year when there is no recession, but since we are looking ahead to 2015 what is important is that we have never seen two down years in a row outside of a recession – so if you are indeed of a bearish mindset for the energy sector for the coming year, keep that in mind; you are making an implicit bet on a U.S. or global recession (low odds, in my view).
And in those years when the S&P Energy sector dropped in the context of a non-recessionary backdrop, the average rebound the following year was +15 per cent – that is not a forecast as much an observation.
Sometimes being lucky means not becoming paralyzed by your analysis as much as merely respecting historical patterns.
The same holds true for Utilities, which now trade at a record high price-to-earnings multiple of nearly 20x (priced as if they are growth stocks). A 24 per cent surge as we saw in 2014 is a one-in-15 year event and these do not tend to get repeated.
In fact, if you do want some interest rate exposure in the portfolio, you may be better off opting for the Telecom space which endured a 2 per cent decline last year.
With classic mean-reversion moves in mind, whenever we have seen Utilities stocks up in the same year that Telecom stocks decline, we see the exact opposite happen the following year. In fact, this was the case in all seven episodes I could identify over the past four decades – and in the ensuing year, the Telecom sector outperformed the Utilities space every time and by an average of 1,300 basis points.
There may well be reasons to like Utilities, as expensive as they are, but history is recommending that a shift is in order (and at a 3.3 per cent dividend yield, Energy at 2.8 per cent is quickly catching up and Telecom already far exceeds what the Utilities space provides with a huge 5 per cent yield).
It seems like the analysts are also shying away from Health Care – only one of the 10 had the sector on the favoured list for 2015.
Again, understandable after the 23 per cent gain of 2014, which makes it three years of double-digit gains but history shows that when Health Care stocks make it three in a year of such large appreciation, like 1982-84, 1988-90, and 1995-97, the sector makes it four in a row.
Health Care is very streaky and if it makes it three years in a row of hefty gains, it goes on for a double-digit gain for a fourth year nearly all the time. Keep in mind that this is one of few areas that historically stands a better than 80 per cent chance of making you money every single year – compare that to Utilities where the odds are closer to 70 per cent (same for Technology) and hardly generate the growth potential that is inherent in the Health Care space.
The only other sector that commands an 80 per cent annual record in terms of generating positive annual returns is the Consumer Staples sector – up 13 per cent last year even as the strategists ignored the group. This sleeper of a sector has now generated double-digit gains in five of the past six years and seven of the past nine.
The Financials rose 13 per cent in 2014 and have now made it three years in a row and five of the past six of double-digit advances. The key here is that the S&P Financials outperformed the broad market by nearly 200 basis points last year and the only time you get recessions is when this group starts to lag behind.
Like the yield curve, the relative performance of the Financials is a canary in the coal mine, and last year's outperformance, as history would have it, is signalling another year of economic growth.
And if that is the case, remember what I said above – Energy stocks rebound nicely a year after a decline that was not associated with an outright economic contraction.