At the start of each year, I put together a list of predictions made by gurus (and often repeated by investors, who hear about these forecasts through the financial media). It’s sort of a consensus of things “sure” to happen in the upcoming year. We keep track of these “sure things” with a review at the end of each quarter. With the turn of the calendar into April, it’s time for our first check of 2016. As is our practice, we’ll give a score of +1 for a forecast that came true, a score of -1 for one that was wrong and a 0 for one that was basically a tie.
Fed Holds Back On Interest Rates
Our first sure thing was that the Federal Reserve will continue to raise interest rates in 2016. That frequently leads to the recommendation that investors limit their bond holdings only to the shortest maturities. After seven years of the most accommodative monetary policy in U.S. history, on Dec. 16, 2015, the Fed, as widely expected, approved a quarter-point increase in its target funds rate from 0% to 0.25% to 0.25% to 0.5%. It has remained there since then. Score: -1.
The second sure thing was that economic growth, while remaining relatively tepid, will improve. The Federal Reserve Bank of Philadelphia’s fourth quarter 2015 Survey of Professional Forecasters predicts unremarkable real GDP growth of 2.6% for this year, which is slightly higher than the final 2015 real GDP figure of 2.4%. Unfortunately, the latest 2016 estimate forecasts more tepid growth—just 2.0% for the first quarter, and just 2.1% for the full year. With no signs of improvement yet, we’ll have to call this one wrong. Score: -1.
Our third sure thing follows from the first two. With the Fed’s monetary tightening and the economy improving—and with the economies of European and other developed nations still struggling to generate any growth, and with their central banks still engaged in easy monetary policies—the dollar will strengthen. The dollar index ended last year at 98.69. It closed the first quarter of 2016 at 94.63. Score: -1.
The fourth sure thing is that with the cyclically adjusted price-to-earnings (CAPE) ratio at about 25.9 as we entered the year, almost 60% above its long-term average, U.S. stocks are overvalued and thus should be avoided. The Vanguard 500 Index Fund Admiral Shares (VFIAX) finished the first quarter of 2016 with a total return of 1.3%, higher than the return on cash or cash equivalents. Score: -1.
Small Caps Neck-And-Neck With Large Caps
The fifth sure thing is that, given relative valuations, U.S. small-cap stocks will underperform U.S. large-cap stocks. Morningstar data showed that, near the end of 2015, the price-to-earnings (P/E) ratio of Vanguard’s Small Cap Index Fund Admiral Shares (VSMAX) stood at about 20.6, while the P/E of the Vanguard 500 Index Fund Admiral Shares (VFIAX) stood at roughly 18.5. In the first quarter, VSMAX returned 1.0%. VFIAX returned 1.3%. The difference is a rounding error, so we’ll score this a draw. Score: 0.