A Report Card on what I was expecting a year ago

It is folly to try and forecast many things, particularly in the short term. One thing I have learned over time is that the forecasts made by even very smart people in their field of expertise are often wrong. That is particularly true of financial markets. However, as we need a view to inform our decisions – even if it is to do nothing – I try to write mine down. It is sobering to reflect on what you were thinking a year ago. I tend not to make too many brave or outrageous forecasts, even though that can be fun, so here is a brief report card on last January’s predictions, which you can check here if interested:

  • What will a Biden Presidency mean for US & Global financial markets? I said not to expect anything too radical as the more conservative Democrat congress members were unlikely to support any big changes. I thought that neither monetary nor fiscal support would be withdrawn too quickly so the consensus outlook for the US economy and share market remained moderately positive. Right on Congress and policy but too conservative in terms of the response of the share market.
  • Are we in a stock market bubble? I thought there was no conclusive proof that we were in a bubble and that prices might keep rising for the foreseeable future as interest rate rises were unlikely. While assets were not cheap, that wasn’t an argument for being overly defensive, particularly when returns on cash and bonds were so low. Pretty much right on that forecast, though I certainly didn’t anticipate the market being as strong as turned out.
  • The risk that Covid-19 Vaccines won’t necessarily end this epidemic soon. I noted that financial markets were assuming that the roll-out of vaccines would be successful and end the health and economic disruption caused by Covid-19. I observed that there was a real risk that mutations would render the new vaccines ineffective and if that happened, we would undoubtedly see the disappointment reflected in lower share prices as confidence would take a big hit. I was right on the risk of mutations, and it has hit confidence – everyone is fed up with lifestyle constraints and uncertainty caused by Covid – but it has not had any lasting impact on either the share market or the property market. So wrong on the implications.
  • Tesla, an example of some highly questionable company valuations. I simply got this wrong as while I thought Tesla was an example of an overvalued tech company, its share price rose by 56% during 2021. The overall US market (S&P500) was up 27% in 2021, a tailwind. Tesla production and sales grew strongly and are likely to reach 2 million in 2022. Margins are up, new products and services are coming, and governments worldwide are encouraging the adoption of electric vehicles. Tesla faces increasing competition from traditional car companies and start-ups like Rivian, Lucid & Nikola, but I concede that it is risky to bet against them (and other tech titans like Apple, Google, Netflix & Amazon) given the substantial first-mover advantages.

 

In summary, like most forecasters, I was wrong on almost as much as I was right. In my defence, I have plenty of company. The takeout is to have a sound long-term strategy and don’t make big bets on shorter-term forecasts which often turn out to be wrong. It is much easier to forecast things like share markets and the property market in the long term than in the short term.

 

Some Forecasts for 2022

With the preamble that many of these forecasts are likely to be at least partially wrong, if not completely so, here goes.

  • Interest rates in Australia will rise, but only modestly, so the return on Term Deposits will remain low and unattractive. Negative returns on cash after taking into account inflation and tax will continue to encourage investment in real assets like property and the share market.
  • The Covid pandemic is far from over, but the worst is probably behind us. While Omicron is spreading very rapidly across all countries, vaccines are proving effective in reducing the severity of illness. Yes, hospital systems are under real pressure, but that is expected to ease within a few months. There is obviously the possibility of a more dangerous variant emerging but with vaccination rolling out to the less developed world and future improvements to the effectiveness of the vaccines, most epidemiologists expect that Covid will become something more like flu. Let’s hope so!
  • After such strong gains in the share market in 2021, similar gains are highly unlikely in 2022. My base case is a modest increase, though a correction of 10-20% at some point during the year is quite likely. Something unexpected always has the potential to produce a substantial downturn, particularly from current record levels. If this occurred, it would likely represent a long-term buying opportunity.
  • The Australian election will be close, as it usually is, but the polls which favour a Labor win are likely to be right this time. Labor is determinedly presenting a small target and the Government has taken a lot of hits over the past 2 years so a small swing against the Government shouldn’t surprise. It is highly unlikely that the election of a Labor Government would bring major changes in most policy areas so I doubt the share market would have much of a reaction.
  • Whoever is in government after the Australian election will ramp up immigration given we have labour shortages in many areas and immigration spurs economic growth even if it isn’t clear that it benefits the average citizen.
  • With interest rates remaining relatively low, economic growth strong, and immigration set to rebound, it is hard to see residential property prices falling significantly. More modest price increases are the most probable outcome. Regulators may constrain bank lending which would restrain price growth. Affordability is a big issue so lower cost markets like Brisbane will probably do better than Sydney & Melbourne.
  • The take-up of electric vehicles will accelerate strongly as availability and pricing improve and the charging network expands.
  • The focus on ESG (environmental, social & governance factors) in funds management will continue to grow and become embodied in the process used by most managers even if they are not explicitly ESG-focused.

 

Inflation in the US and the impact on Equity Markets

Predicting inflation is very difficult but there are clear signs that the large increase in US inflation over the past year is more than transitory or temporary so even if technological and other factors are likely to depress inflation over the medium to longer term, US inflation will likely remain elevated over the next year or so. Normally this would be negative for equities as inflation can squeeze margins if increased costs cannot be fully passed on. However, US companies are currently very profitable and while there is real wage pressure in the US, US companies can and are raising prices to offset this wage pressure. In a strong economy that has been buoyed by government fiscal stimulus and low interest rates, consumers are accepting higher prices. This explains why the US equity market remains at record levels even if some currently unprofitable highly valued tech companies have suffered price falls.

 

Andrew’s Retirement

It is still my intention to retire fairly soon so this may be my last monthly newsletter. Thanks for reading over the last 10 years and particularly to those who have provided feedback.

 

This newsletter contains general advice. It does not take into account your individual objectives, financial situation or needs. You should consider talking to a financial adviser before making a financial decision.

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