The world was very young then, and many things did not yet have names, and to indicate them it was necessary to point.” -Gabriel Garcia-Marquez, One Hundred Years of Solitude
Ah! as the heart grows older it will come to such sights colder by and by nor spare a sigh though worlds of wanwood leafmeal lie; and yet you will weep and know why”- Gerard Manley Hopkins, “Spring And Fall To A Young Child”
When I was a boy I often took a bus during the holidays from my small (8,000) home town of Clinton, South Carolina, for the 40-mile trip to the metropolis of Greenville (then maybe 40,000). Greenville had one brokerage with a viewable ticker tape, Thomson and McKinnon, and I delighted in sitting among the old guys in shabby suits who were glued to it. They tested me with questions about which companies the tickers stood for and I could generally answer them because the office manager gave me month-old copies of the Standard and Poor’s gray book. He also let me take anything else I wanted from brokerage material spread out on a big table. I started doing this around 1957.
Nothing could have been more fun, especially as I got taken to lunch by my war hero uncle – my personal hero – an actuary/mathematician who had worked out pretty much everything about option time decay that Black and Scholes eventually got a Nobel Prize for. He explained the convertibility of puts and calls, and everything you need to know about straddles, with which he did buy/writes off the ads which were then in the margins of the Wall Street Journal. My uncle was not a fundamental investor. He explained once that he preferred stocks without earnings, like Transitron Electronics, because earnings just complicated the pure math of it. Are you listening Tesla (TSLA) and Netflix (NFLX)?
At one of those lunches he introduced me to his broker, Mr. Doherty, who let me buy things with paper route money in a custodial account. He also sent me home with an armful of market material. I bought five or ten shares of Standard Oil of Ohio and Amerada Petroleum (I had written for and received their annual reports). Mathematics and statistics weren’t everybody’s game, and I was on the path to being a value investor. What I liked about the oils, which were blue chip growth stocks in those days, was learning how to track the three phase journey of crude oil from a sandy field in Libya to the cracking process in a giant refinery, and on to gas stations like the one at which we filled up our car. Both stocks actually went up and I sold. It was fairly hard to lose money in the 1950s.
What did I really know? Basically nothing, but it was not from lack of trying. What I really loved on those holiday trips was getting my hands on any kind of institutional forecast for the coming year. I read everything and memorized quite a bit of it. The world was very young then, and so was I (about 13), and there was a wonderful innocence in those annual forecasts which matched the innocence of their reader.
I was a bull market boy. I was born into the best and most uncomplicated of all bull markets. Every positive forecast turned out okay. All you had to do was stick to airlines, aluminum, chemicals, drugs, IBM (IBM), and consumer growth, especially leisure companies like Outboard Marine and Brunswick Balke Collender. Boats and bowling were great growth industries. In a year or two every American would own a boat with an outboard motor and spend every Friday night in a bowling alley.
There was something wonderfully straightforward and sincere about those forecasts. I kept the best ones on my nightstand and read them over and over. I started posting stock prices and volume daily on sheets of logarithmic graph paper I had McGee’s Drugstore order. If nothing else I had learned one basic fact: the world was all about information. I gradually started learning to consider the source. It wasn’t until the 1970s that it fully dawned on me that the market had lost its innocence, or maybe I had. Ah! as the heart grows older…
It was partly nostalgia which got me to do a systematic reading of this year’s major institutional outlooks. I started reading for amusement but realized that I was actually learning things. One of the things that hasn’t changed is that there are many ways of coming at the markets. You should consider reading all the below-mentioned outlooks, which come at the markets from a number of different perspectives. They are free (you’ll need to go to your library for the December 17 Barron’s for the best version of Schwab’s). The thing to remember is that they require a bit of interpretation. You may learn very different things than I did. Remember to start by considering the source. What follows are some of my observations.
How To Read Institutional Forecasts
Here are a few tips:
- Understand the nature of the institution so that you know where its views are coming from.
- Know the basic point of view of the institution.
- Know the customer base the institution serves.
- Know the underlying ideology or set of principles guiding the institution.
- Know where the author or authors of the outlook fit into the institution.
- Know the constraints under which the framers of the outlook operate.
- Above all, know what the institution is selling.
- Keep your eyes open for little oddities which jump off the page – especially those you wouldn’t expect from a particular source.
The Vanguard Outlook
I’m probably Vanguard’s worst customer. The only Vanguard funds I own are their money market funds and their Long Term Tax Exempt Fund (VWLUX), which I recently bought. Meanwhile they offer me an enormous number of free trades in several brokerage accounts although I rarely do more than a couple of trades a year. I wonder if there is any way to sell those free trades the way companies sell carbon credits? I do love Vanguard. Their money market funds are great and it’s easy to make a trade or track things in my brokerage account. A very nice Flagship guy is always there to help when I am dumb about the mechanics of something (I’m high maintenance because I refuse to read the boilerplate stuff in their publications on settlement dates and what you can and cannot do). Plus I love Jack Bogle, have read his books, and appreciate his no-nonsense recent opinions on the markets (unambiguously calling for caution).
The essence of Vanguard is integrity. It doesn’t have owners and is pretty much honest when it says that you, the customers, are the owners. It specializes in low cost plain vanilla products, having been the first mover with index funds. It was founded on the principle of amassing wealth slowly and deliberately by simply taking what the market gives and avoiding overly complex ideas. Its regular advice for years has seemed to me obvious and true, helpful for uninformed investors but not terribly insightful or useful for me. Given any question on investing, I knew exactly what they would say.
I came to Vanguard’s 2019 outlook with the expectation that it would be sound but formulaic, grounded in mega-data drawn in a linear fashion from market history and presented by guys in dark suits who have slightly thin blood. I was wrong, maybe not entirely about the dark suits, but totally wrong in some subtle but very important ways. Vanguard is actually capable of having a point of view, and that point of view as expressed in their 2019 Outlook serves as about as good a baseline as I have seen.
Vanguard begins with the pictures and pedigrees of the Outlook group, six men and two women, five economists and three market strategists, all in subdued suits, none of whose names or faces you are likely to know from CNBC. That’s a good thing, I think. They look competent, and their work confirms this assessment. The foreword explains that they use a probabilistic approach, which I also do (without quite so much crunching of numbers), and this probabilistic approach informs the presentation. They cover both the US and the world. Their expectation, the most probable take on the new year, is a slowdown in growth (2%) but no recession in 2019 (30% probability). Low inflation. Fed raises to 2.75-3%. Long in the works, their immediate expectation probably doesn’t reflect important and more negative recent data.
Their fixed income expectation rises from 1.5-3.5% for last year to 2.5%-4.5% for this year. My expectations for my own recently constructed fixed income portfolio are at the higher end of that for taxable equivalent returns. But here’s the big one. They expect equity returns for a 10 year period to be 4.5-6.5%, way down from the 12.6% average since 2009. My goodness, Vanguard is sticking its neck out, and the numbers they come up with are exactly the ones I use. They seem to have placed emphasis on valuation, using sources beyond the standard last year/next year PE that drives a lot of sell-side drivel. It’s the right time frame, from my perspective, as any given year is just statistical noise. Such low estimated return is a bit sobering and I imagine that only a powerful sense of responsibility forces them to peel back the onion and show what their numbers are really implying.
I have a special appreciation of their use of probabilistic bands. They present normal curves showing that their number range encompasses half the probabilities. They include a tabular format as well with a bracketed line showing the numbers which encompass the next 40%. That’s the way I like to think about probable outcomes. Is there really any other valid way to think about the future? There’s also quite a lot of detailed and helpful information about other parts of the world.
The last section of the outlook deals with model portfolio strategies starting with the standard 60/40 portfolio which includes a mix of foreign and domestic assets. There are two variants, one optimized for higher growth with a bit of inflation and the other for lower growth with a recession. It’s no surprise that 60/40 does not do the best in all cases, but it doesn’t perform the worst in any scenario. That speaks for itself. The strategists leave it at that. The article ends by documenting sources and indexes used for their return estimates.
This, folks, is what a baseline Outlook should look like. It gets an A+. It’s free on page one of the Vanguard site or you can read it from this link.
The Morningstar Outlook
Morningstar got its start evaluating mutual funds using a star system – a system sometimes criticized for being backward looking. It nevertheless marshals a great deal of fund data and has also developed into an independent analyst of individual stocks, putting together such things as lists of buys by successful value investors. Each stock comes with a ranking of the strength of its moat and its price relative to Morningstar’s estimate of fair value.
In many respects Morningstar appears to have a view similar to that of Vanguard, but its sourcing is quite different. Here’s a short summary piece, but their better forecasts involve specific areas. There is little of the sober, data driven, PhD-guided analysis of Vanguard. Instead Morningstar relies on the views of star fund managers based on its extensive knowledge in the fund area. If I had to read one outlook I would prefer Vanguard, but Morningstar provides a nice counterpoint coming from a slightly different direction.
Fidelity’s outlook appeared in my email inbox this morning as I was about ready to do a final edit. I decided it fit best as a tack-on to Morningstar. Both were constructed as a composite point of view of active fund managers. Its overview was similar to most others – slow growth but probably no recession, keep an eye on rates and trade, consider defensive sectors. That matches up with the products Fidelity markets and that its customers are interested in. The most interesting thing out of Fidelity in recent months was the public acknowledgement by CEO Abby Johnson (in an October 7 Barron’s cover story/interview) that the days of the traditional active money management model were numbered. Morningstar gets a B. Fidelity gets a C+.
The Schwab Outlook
The Schwab clientele tends to combine interest in individual stocks with both active funds and low cost index funds cast from the Vanguard mold. Its chief investment strategist and primary author of Schwab’s U.S. Outlook is Liz Ann Sonders, the major public face of Schwab and a face I remember going back to the days of Louis Rukeyser’s Wall Street Week. Even then, as a youngster in the industry, she had a cool head and willingness to stick her neck out from time to time. Her feature interview in the December 17 issue of Barron’s (p. 40) recapitulates the Schwab Outlook but enlivens and enhances it with a few added nuances.
Sonders is somewhere between cautious and outright bearish, doubtful of the consensus earnings growth estimates of 6-8%, and not afraid to reel off what she sees as deterioration in key economic indicators. She sees 2018 as having been a “stealth” bear market and expects if not an outright bear in 2019, then a series of rolling bear markets that ripple through sectors. She is concerned with China, tight money, and global populism.
The most interesting element of her view is the importance she places on anecdotal sources – information she gets while traveling the country to conferences as the face of Schwab. That anecdotal evidence provides a useful counterpoint to the systematic number-crunching and probabilistic estimates of Vanguard, and the two approaches complement one another as they represent the styles and customer needs of two different institutions. The anecdotal evidence brought up by Sonders includes emails received by her sister, an interior designer, from plumbers and other suppliers who are saying that they are “instituting 20% to 25% price increases by the year-end because of trade concerns.” That’s a very bearish tell for corporate profit margins, and part of broad anecdotal evidence that seems outright bearish.
The Sonders interview is the gem of the Barron’s 2019 Outlook issue. The larger and more general feature piece, citing a number of familiar chief analysts from brokerage firms, is useless at best. All but a couple of the analysts were conventionally positive, but the format of having all ten of them provide single number/single year targets for the S&P 500 is simply dumb. They also forecast S&P earnings, GDP growth, and 10-Yr Treasury Yield with the same spurious specificity. I mean, what kind of nitwit process gets one chief brokerage analyst to say 3000 for the S&P while another says 3100? Do those opinions make you any smarter? Oh, and they have Favored Sectors and Sectors To Avoid, with a large middle group of sectors landing on both lists. Pretty much everything is wrong about this approach, starting with the specious precision of the numbers and including the silly implication that forecasting is a sort of competitive game. Schwab gets an A for the delightfully honest and courageous Liz Ann Sonders. Barron’s gets a D, saved from an F by the Sonders interview.
The IBD Outlook
IBD, for those who are unfamiliar, used to be Investors’ Business Daily, the brainchild of William O’Neil who created it to acquaint the multitudes with his CANSLIM method. The CANSLIM approach combines fundamentals such as earnings growth with momentum and chart patterns. It began as the hip alternative to the Wall Street Journal, focused especially on stock market data for investors interested in IPOs and popular new growth stocks. This was never really my game – and a couple of small forays into it had mixed results – but I find it useful to read occasionally because it is actually quite good at confirming (or failing to confirm) market turns and keeping you up with the current enthusiasms of growth investors.
As a hard copy publication IBD has been published weekly since 2016, but you can get daily updates as an online subscriber. I bought the 2019 Outlook issue and found it both helpful and amusing. Here were a few surprises:
- Their featured manager, from a favored company, T. Rowe Price, seemed unusually guarded about earnings growth and small cap stocks.
- They mentioned Berkshire Hathaway (BRK.A)(BRK.B) among four recent top gainers (the Oulook edition being dated December 31). They went on to do a full paragraph on Berkshire noting that it was 9% off its high but that the “relative strength line for the diversified operations conglomerate is at a high, which is bullish.” Things like relative strength lines are of great importance to IBD. The fact that it paid any attention at all to a graybeard value stock like Berkshire suggests that the world of rapid growth investing is in utter chaos.
- Another piece about utilities as current market leaders is best summarized by its concluding sentence: “If the market is to provide an atmosphere for growth investors, something other than utilities must lead.” Honest. Correct.
- Most interesting of all, the IBD 2019 Financial Action Plan concludes with a section entitled: Consider Bonds. Consider what? Bonds? Coming from IBD? It’s as if Osservatore Romano issued a 2019 Outlook with a headline suggesting that Catholics Cut Back On The Hail Marys And Give Serious Consideration To Secular Humanism.
For those able to read between the lines, it’s clear that IBD has thrown in the towel on the market until further notice. Hooray for them! It’s as if the class clown had turned in an amazingly insightful and witty final exam. Let’s give them an A-.
These aren’t your grandfather’s annual outlooks. Nobody in your grandfather’s day had Vanguard’s solemnity, comprehensiveness, and the sense of responsibility to produce a carefully probabilistic picture backed by hard data. In your grandfather’s day you wouldn’t have been treated to the down-to-earth wisdom of Liz Ann Sonders because there were no females in the industry. (The first female member of the NYSE was Muriel Siebert, who managed to buy a seat in 1967). Nothing like IBD existed at all, so it wouldn’t have been around to deliver shocking opinion.
The real question is what to make of outlooks which run from very diminished expectations to outright pessimism. Are they contrary indicators or do they, coming from their different perspectives, give us important insight into the range of outcomes which may lie ahead. I know what I think. What about you? Do you have a favorite institutional outlook of your own?
Disclosure: I am/we are long VWLUX, BRK.B. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.