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2008 Report Card |
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PreviewIn this issue, I review some of the major themes from 2008 and evaluate the investment outlook in the January 2008 Newsletter. On the whole, I did a pretty good job of avoiding the disaster investments but certainly left room for improvement in suggesting investment alternatives. Avoiding crash sectors like real estate, finance, and retail were key to having a good year, but falling prices in almost every asset class made most investments besides cash and gold perform poorly in 2008. Here is the investment outlook that I proposed at the beginning of the year along with a grade ranging from A-F for each category:
2008 Review2008 was a tough year to earn a positive return. The only strategies that really worked were holding U.S. dollars and gold. Between August and November, the dollar appreciated by nearly 20% against a basket of other currencies but has since given back most of the gains. Holders of U.S. Treasuries had a good year, with 10-year yields falling to levels not seen since the 1950s. Gold was a similarly successful investment by not losing any value this year, meaning that it gained relative to almost every other asset class.
U.S. Stocks: Financial, Lending, Credit, Construction, Retail, and Real Estate (Prediction: Most Unfavorable, Grade: A)Investments in the financial sector were absolutely crushed this year. Pretty much anything relating to finance, banking, credit, consumption, retail, and real estate had a bad year of historic proportions. Here are some sample stocks and indexes: U.S. Residential Real Estate (Prediction: Most Unfavorable, Grade: A)Housing markets across the country continued to deteriorate this year, with prices falling an average of 17.4% in the 20 largest metropolitan areas. These losses don't seem as bad as the stock market until you remember that many homeowners and investors are leveraged 5 or 10 times after obtaining a mortgage. 1-year home price changes: S&P/Case-Shiller metropolitan indices Most markets continue to be weak with no clear signs of turning around. Perhaps mortgage rates falling to a 37-year low will bring some buyers off the sidelines, but I still don't expect home prices to appreciate on a national scale anytime soon. U.S. Stock Market Indexes (Prediction: Unfavorable, Grade: A)A traditional stock market index strategy didn't work this year either. The S&P 500 and the Dow Jones Industrial Average are down 40% and 36% for the year:
I certainly did not predict a stock market crash. If I did, I would have made a more aggressive bet against it. But here's what I wrote in the March 2008 Newsletter: "except for the peak of the Internet Bubble, today's stock market has the worst overall outlook in the last 60 years." Crash or no crash, stock market valuations were too rich to provide an adequate return. U.S. Commercial Real Estate (Prediction: Unfavorable, Grade: A)Commercial real estate stocks maintained value until late in the year, falling only after the real economy started to crumble. I suppose investors were doubtful that losses in residential real estate would spill over to the commercial side. Major stock losses in this sector did not occur until September, when prices crashed and many stocks lost 50% or more in a matter of months.
Technology Stocks (Prediction: Neutral, Grade: B)Technology stocks were a bit trickier, from my point of view. I have been writing about overvalued technology stocks for some time (see here and here), but prices kept rising anyway. A few of my friends enjoyed ridiculing me when Research in Motion kept going up in price after I declared it to be a possible shorting opportunity. Back in January, I outlined my newsletters for the year and planned to write one titled, "Why tech will eventually go bust (again)." Unfortunately, I never got the chance because technology has already gone bust. Profits in technology are based on consumer demand just like everything else, so when consumers run out of money as they did this year, future earnings can evaporate very quickly. The tricky part about technology stocks (and why they can easily become overvalued) is that valuations are based on earnings projections far into the future. It's very easy to tell stories or make projections that justify high price to earnings ratios for Google or Apple. But projections can change quickly when the economy takes a turn for the worse. In the end, I was right to avoid technology stocks, but I gave them a Neutral rating because I had no idea if/when they would actually crash. Unfortunately, I missed out on one of the best shorting opportunities of 2008. But look for 2009 to possibly be a good year to buy tech companies with strong fundamentals. Personally, I'd rather buy into technology during a recession, when valuations don't reflect overly optimistic earnings projections.
International Stocks (Prediction: Favorable, Grade: F)One thing that I got dead wrong was underestimating the extent to which the world economy would be affected by this recession. Here was my thinking: I know the U.S. is headed for at least a ''hard landing'', so what are the viable alternative investments? International stocks seemed to provide the type of diversification I was looking for. In retrospect, diversifying internationally provided the same sort of protection as did owning mortgage-backed securities from a variety of U.S. cities. My investment view was to avoid North America and Europe and to buy into South America and Asia. Perhaps future years will redeem this choice, but for 2008 this was a horrible strategy. Here is a sample of international ETFs and their performance this year:
U.S. Stocks: Consumer Staples (Prediction: Favorable, Grade: B)The basic strategy with consumer staples was to be defensive in a U.S. recession but to allow for growth in case the recession never came or was milder than expected. Even with the recession and crisis being as severe as they were, stocks relating to basic consumer items didn't do so poorly. Here are some examples:
Oil and Commodities Stocks (Prediction: Favorable, Grade: D)I'm certainly not an oil or commodities expert, but I'm expecting these asset classes to outperform over the next few years through the lens of Asset Class Rotation, whereby long-term cycles in investor sentiment make certain asset classes undervalued/overvalued relative to others. Hard assets went through a 20 year bear market characterized by low inflation and rapid growth of the U.S. service sector. If you believe, like I do, that today's loose monetary policy and fiscal stimulus will eventually become inflationary, then oil and commodities provide a better investment opportunity than the broad stock market indexes. In 2008, oil and most commodities experienced major price spikes in June/July which ultimately collapsed during the latter part of the year. Like international stocks, neither provided the sort of diversification or insulation from a broad stock market decline that I had hoped for. But there were winners and losers within this sector, and it remains to be seen whether this is a successful longer term strategy.
Gold and Gold Stocks (Prediction: Most Favorable, Grade: B)Gold itself was one of the few investment classes besides cash that preserved wealth this year. The price of gold experienced substantial volatility in 2008 but is trading roughly at the same price as it did at the beginning of the year. The gold miners index had a lousy year (GDX) but still barely outperformed the S&P 500. The index fell from $56 to $17 (a 70% crash) between March and October and then rose back to roughly $30 a share through December. Year-to-date, the index is down around 35%. All in all, gold wasn't such a bad call for 2008. As I wrote in the April 2008 Newsletter: "Long-term investors shouldn't care whether gold goes up in dollar terms, only whether gold is able to buy more stocks in the future." One ounce of gold bought 0.57 shares of the S&P 500 in January versus 0.96 shares today, making it a great trade for the year. In this respect, gold and cash had pretty much the same outcome in 2008, but there is no guarantee that both will do equally well in the future. More to come on this topic in the January 2009 issue.
ConclusionHere are some excerpts from my January 2008 newsletter:
Looking back, I'd say that I was spot on for my economic outlook but had a mediocre investment strategy. I did a great job of knowing what assets to avoid but lacked insight for successful alternatives. Others, like Kevin Depew of Minyanville, had similar years. In retrospect, the two best strategies in 2008 were to hold cash and to short the market. I did a bit of both but certainly nowhere near enough. Bravo to Eric Janszen and the iTulip team who as usual called everything pretty much perfectly (see "You too can forecast recessions! Secrets revealed! Here’s how!"). |
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