As a forecaster on The Good Judgment Project, I compete in estimating the probabilities of political and economic events for the Intelligence Advanced Research Projects Agency. One of the lessons I've (re)learned is that "it is exceedingly difficult to make predictions, particularly about the future," to quote physicist Niels Bohr. That gives no pause to financiers, pundits, and experts of all stripes who are always willing, around this time, to offer their predictions for the following year. I won't be left out; here are mine.
U.S. GDP growth will come in below 2%.
In November, the Federal Reserve Board members and Federal Reserve Bank presidents revised their growth projections downward to a "central tendency" of 2.5% to 2.9% and a range of 2.3% to 3.5%. Those estimates look generous to me: Since 1930, average annualized GDP growth is 3.3%; in the post-war era it's 2.9%. With those figures in mind and given the current environment, 2% growth next year would be a good result.
Accelerating growth is typical for an exit from an economic slump, but the height to which a coiled spring bounces back is a function of the degree to which it has been compressed. The Fed took the bite out of the downturn; by symmetry, expect the recovery to remain muted -- particularly so in a climate of extreme uncertainty.
Corporate earnings growth will slow sharply; earnings may even shrink. The S&P 500 will miss its 2012 EPS forecast ($99).
If analysts' estimates of 2012 earnings hold, the S&P 500's earnings per share in 2012 will be just shy of $99, for a 10-year annualized growth rate of 13.6%. Assume 3.5% inflation for next year and the companies in the S&P 500 will have increased their earnings at an average rate of nearly 10% over a 10-year stretch on an inflation-adjusted basis (9.7%, to be precise). You need to go back to the decade ending in 1956 to find a similar period over which real earnings grew that fast. During the following year, 1957, earnings fell by 4% on a real basis. During the following decade, the annualized earnings growth rate fell by two-thirds to 3.2%.
Hang on, weren't earnings depressed 10 years ago as the economy absorbed the twin impacts of the technology bubble meltdown and the 9/11 attacks? Wouldn't that skew upward any growth figures from that point forward? No question about it: 2001-2002 was a trough period for corporate earnings. But so was 1932, surely: Earnings had fallen by two-thirds, inflation-adjusted, from their 1929 peak. Despite this, from 1933 through 1942, companies managed to grow earnings at "only" 7% on a real basis. Ten percent -- the current rate -- is a stratospheric growth rate that will not hold much longer. The timing and magnitude of the slowdown cannot be known with any precision, but it will occur -- count on it.
Volatility will remain high.
I'm hardly going out on a limb with this prediction. Part of what you are being paid for when you hold stocks is your capacity to endure price risk. That capacity was certainly tested this year. During the summer, the VIX index -- which measures option traders' expectations regarding future stock price volatility -- reached levels it had not achieved since, well, since the previous summer.
There is an embarrassment of risks out there, of which the European sovereign debt crisis is currently the most high-profile, keeping markets focused on macroeconomic factors. Expect the VIX to break 35 again this year and the risk on/risk off schizophrenia to remain a fixture in risk asset markets.
My picks for the three best-performing stocks in the Dow index: Bank of America (NYSE: BAC ) , Alcoa (NYSE: AA ) , and Hewlett-Packard (NYSE: HPQ ) .
Financials (B of A) and materials (Alcoa) were the worst-performing sectors in the S&P 500 -- by a considerable margin. Given the current sector valuations (2012e P/E for materials: 11.4, financials: 9.7), it wouldn't be surprising if cyclical companies had their day in the sun in 2012. As for HP, when a business has healthy underlying fundamentals and investors revile the stock for reasons the company can address -- that's the time to buy in, then bide your time.
My picks for the three worst-performing stocks in the Dow index: Home Depot (NYSE: HD ) , Kraft Foods (NYSE: KFT ) , and McDonald's.
Stocks that outperformed in 2011 and over the past three- and five-year periods, and that are now priced at a healthy premium to the index, will perform poorly on a relative basis -- even a consumer-staple stock like Kraft.
Note: Trying to pick winners and losers over a one-year time frame is like a potluck, and that's the spirit in which you should read these predictions. Do your own due diligence whenever you put any money at risk.
It's your turn
If you disagree with my predictions, tell me why in the comments section below and/or give me your alternative prediction.
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