Almost All of Wall Street Got 2012 Market Calls Wrong
By Michael Patterson and Lu Wang – Jan 4, 2013
From John Paulson’s call for a collapse in Europe to Morgan Stanley (MS)’s warning that U.S. stocks would decline, Wall Street got little right in its prognosis for the year just ended.
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Paulson, who manages $19 billion in hedge funds, said the euro would fall apart and bet against the region’s debt. Morgan Stanley predicted the Standard & Poor’s 500 Index would lose 7 percent and Credit Suisse Group AG (CSGN) foresaw wider swings in equity prices. All of them proved wrong last year and investors would have done better listening to Goldman Sachs Group Inc. (GS) Chief Executive Officer Lloyd C. Blankfein, who said the real risk was being too pessimistic.
The ill-timed advice shows that even the largest banks and most-successful investors failed to anticipate how government actions would influence markets. Unprecedented central bank stimulus in the U.S. and Europe sparked a 16 percent gain in the S&P 500 including dividends, led to a 23 percent drop in the Chicago Board Options Exchange Volatility Index, paid investors in Greek debt 78 percent and gave Treasuries a 2.2 percent return even after Warren Buffett called bonds “dangerous.”
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“They paid too much attention to the fear du jour,” Jeffrey Saut, who helps oversee about $350 billion as the chief investment strategist at Raymond James & Associates in St. Petersburg, Florida, said by phone on Jan. 2. “They were worrying about a dysfunctional government in the U.S. They were worried about the euro quake and the implosion of Greece and Portugal. Instead of looking at what’s going on around them, they were letting these macro events cause fear to creep into the equation.”
The market value of global equities increased by about $6.5 trillion last year as the MSCI All-Country World Index (MXWD) returned 17 percent including dividends
. The Bank of America Merrill Lynch Global Broad Market Sovereign Plus Index of government debt returned 4.5 percent. The MSCI gauge of stocks in developed and emerging markets rose 0.3 percent to 347.68 today.
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While Bank of America Merrill Lynch indexes show Treasuries of all maturities returned an average of 2.2 percent last year, including reinvested interest, an investor who bought what was then the benchmark 10-year note — the 2 percent security due in November 2021 — would have gained 4.01 percent after taxes, according to data compiled by Bloomberg.
Money managers who aim to beat markets lagged behind instead. The Bloomberg Global Aggregate Hedge Fund Index, which tracks average performance in the $2.19 trillion industry, increased 1.6 percent last year through November. More than 65 percent of mutual funds benchmarked to the S&P 500 trailed the gauge in 2012, according to data compiled by Bloomberg. The 50 stocks in the S&P 500 with the lowest analyst ratings at the end of 2011 posted an average return of 23 percent, outperforming the index by 7 percentage points, the data show.
Blankfein was more prescient. “I tend to be a little more positive than what I’m hearing from other people,” the 58-year- old CEO told Bloomberg Television in an April 25 interview at Goldman Sachs’s New York headquarters. “One of the big risks that people have to contemplate is that things go right.”
While markets moved against forecasters last year, their predictions may eventually prove correct.
Ten-year Treasury yields have climbed 0.51 percentage point from a July low to 1.90 percent, while the so-called VIX index of volatility is up 2.8 percent from last year’s nadir. Greece’s economy will contract 4 percent this year, the International Monetary Fund predicted in October, as euro membership prevents the country from boosting exports with a weaker currency.
Paulson, the founder of New York-based Paulson & Co., told clients in April he was wagering against European sovereign bonds and buying credit-default swaps on the region’s debt. The contracts insure against default and increase in value when investor perceptions of the borrower’s creditworthiness decline.
Citigroup Inc. (C) economists led by Willem Buiter in London said in February the possibility Greece would leave the euro within 18 months had increased to 50 percent from between 25 to 30 percent. They raised the risk to 75 percent in May and by July were citing a 90 percent chance of departure, writing in a report that their “assumption” was an exit by Jan. 1.
Greek bonds surged the most worldwide and the country stayed in the euro as the European Central Bank pledged a bigger rescue effort, German Chancellor Angela Merkel softened her stance on aid and Prime Minister Antonis Samaras delivered on austerity commitments in Athens.
Money managers who bet against the conviction of European leaders to hold together the 17-nation currency union missed out on some of the best investment opportunities as the euro strengthened about 9.4 percent from a July 24 low against the dollar, Germany’s DAX Index (DAX) of shares returned 29 percent for the year and credit-default swaps on Portugal dropped 644 basis points to 449.
“There really is only one ‘worst trade’ and that is the ‘euro crisis’ trade,” Michael Shaoul, the chairman and chief executive officer of Marketfield Asset Management LLC in New York, which oversees about $4.4 billion, said in a Dec. 31 e- mail.
Armel Leslie, a spokesman for Paulson & Co., declined to comment. Buiter wasn’t available to comment, Devonne Spence, a spokeswoman at Citigroup in London, said on Jan. 2.
Adam Parker, the U.S. equity strategist at New York-based Morgan Stanley, predicted the S&P 500 would fall 7.2 percent to 1,167 last year as the U.S. presidential election, slower growth in China and Europe’s debt crisis deterred investors. Stocks rose as Federal Reserve decisions to keep benchmark interest rates at record lows while buying more than $80 billion a month of mortgages and Treasuries boosted confidence in the economy.
The average forecast of 12 strategists tracked by Bloomberg called for the S&P 500 to increase about 7 percent last year to 1,344. It reached 1,426.19, surpassing the year-end prediction by the most since 2003, data compiled by Bloomberg show.
Parker said he underestimated the impact of central bank stimulus and investors’ willingness to pay more for stocks. The S&P 500 is valued at 13.2 times estimated earnings, about 9 percent more expensive than it was a year ago, according to data compiled by Bloomberg.
“We were wrong on our year-end outlook for 2012 mostly because of our view on the multiple,” Parker wrote in a report on Oct. 22. “The specter of nearly unlimited intervention from the ECB and the Fed seems to have created a more positive asymmetry than we anticipated.”
Buffett, the chairman of Berkshire Hathaway Inc. (BRK/A) and the world’s fourth-richest person in the Bloomberg Billionaires Index, wrote in a February letter to shareholders that inflation and low yields make fixed-income securities less attractive than stocks or buying whole companies over time.
While U.S. inflation of about 2 percent last year left Treasuries with almost zero real return, U.S. company bonds outpaced the increase in consumer prices with a gain of 11 percent, according to the Bank of America Merrill Lynch U.S. Corporate & High Yield Index.
Buffett didn’t respond to a request for comment sent to an assistant.
Easing concern about a breakup of the euro helped reduce equity volatility, defying the Jan. 12 prediction by Credit Suisse’s Andrew Garthwaite that price swings would increase.
The MSCI All-Country index’s 30-day historical volatility dropped to a six-year low of 6.7 on Dec. 28. The VIX, a gauge of projected market swings derived from options on the S&P 500, fell to 18.02 from 23.4 at the end of 2011, the biggest annual drop since 2009.
Bank of America Merrill Lynch’s MOVE Index, a gauge of Treasury volatility, retreated 35 percent last year. The cost of options on developed-nation currencies declined 34 percent, the biggest annual slump since at least 1993, according to JPMorgan Chase & Co.
“It’s a significant surprise why implied volatility in the foreign exchange market, bond market and equities market is all far, far lower than anyone expected,” Garthwaite, the London- based global equity strategist at Credit Suisse, said by phone on Jan. 2. “Ultimately, we have to put it down to central bank action.”
French bonds rallied even as S&P and Moody’s Investors Service Inc. removed the country’s top credit rating. France’s sovereign debt returned 10 percent last year, more than double the rest of the global government bond market, according to Bank of America Merrill Lynch indexes.
The gains echoed the previous year, when investors considered the U.S. more creditworthy after S&P removed the nation’s AAA grade and drove 10-year note yields to a record low in 2012.
Goldman Sachs’s call on Chinese equities proved too optimistic. Helen Zhu, the New York-based bank’s China strategist, said in a Jan. 11 interview on Bloomberg Television that the CSI 300 Index (SHSZ300) would probably climb 36 percent to 3,200 by year-end. Instead, the gauge of shares traded in Shanghai and Shenzhen peaked at 2,717.82 and ended the year up 7.6 percent at 2,522.95.
“China’s A-share market has seen substantially more valuation de-rating relative to other markets since 2010, larger than we and many others had expected,” Zhu said in a Dec. 28 interview. “Intensifying concerns about structural risks in the economy have resulted in significant volatility in a market which tends to be more sentiment driven.”
Zhu, who’s estimating a CSI 300 index gain of about 9 percent for 2013, wasn’t the only forecaster who proved too bullish last year as government efforts to cool home prices and contain inflation limited equity returns.
About 3,000 recommendations compiled by Bloomberg show analysts overestimated gains for CSI 300 shares by 33 percentage points, the second-most among 45 markets after Russia.
“It’s always more challenging for investors to try and predict political actions,” Khiem Do, the head of Asian multi- asset strategy at Baring Asset Management, which oversees about $50 billion worldwide, said in a Jan. 2 phone interview from Hong Kong. “In general they’re trained to analyze the economic data, balance sheets and so on. They’re not trained to predict political decisions. These factors have ruled the lives of fund managers in a more significant manner than what used to be over the past 20 or 30 years.”