From John Paulson’s call for a collapse in Europe to Morgan Stanley’s warning that US stocks would decline, Wall Street got little right in its prognosis for the year just ended.
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 seven per cent and Credit Suisse Group AG foresaw wider swings in equity prices. All of them proved wrong last year and investors would have done better listening to Goldman Sachs Group 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 US and Europe sparked a 16 per cent gain in the S&P 500 including dividends, led to a 23 per cent drop in the Chicago Board Options Exchange Volatility Index, paid investors in Greek debt 78 per cent and gave Treasuries a 2.2 per cent return even after Warren Buffett called bonds “dangerous.”
“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 January 2. “They were worrying about a dysfunctional government in the US 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.”
Trailing markets
The market value of global equities increased by about $6.5 trillion last year as the MSCI All-Country World Index returned 17 per cent including dividends. The Bank of America Merrill Lynch Global Broad Market Sovereign Plus Index of government debt returned 4.5 per cent. The MSCI gauge of stocks in developed and emerging markets rose 0.3 per cent to 347.68 on Friday.
While Bank of America Merrill Lynch indexes show Treasuries of all maturities returned an average of 2.2 per cent last year, including reinvested interest, an investor who bought what was then the benchmark 10-year note — the two per cent security due in November 2021 — would have gained 4.01 per cent after taxes, according to data compiled by Bloomberg.
Blankfein positive
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 per cent last year through November. More than 65 per cent 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 per cent, outperforming the index by seven 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 per cent, while the so-called VIX index of volatility is up 2.8 per cent from last year’s nadir. Greece’s economy will contract four per cent 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.
Fed stimulus
Adam Parker, the US equity strategist at New York-based Morgan Stanley, predicted the S&P 500 would fall 7.2 per cent to 1,167 last year as the US 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 seven per cent 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.”
