A non forecast 2011 Outlook??

Huh? Why the question mark in the title of this post you may ask? Well, it has to do with my thoughts on forecasts. This time of year is one of the more entertaining. Slews of economists, investment strategists, and research houses put out there forecasts for market performance in 2011. I find this to be one of the more comedic episodes in the Wall Street machine. First, for the forecasts themselves. Jeff Miller and Mebane Faber saved me the work of compiling some of the big name forecasts. From Mebane’s post;

I was going to write an article about recent predictions by Biryini, Shiller, and Prechter but Jeff Miller beat me to it with a great article “Big Names Big Market Calls“.

S&P500 currently around 1270

Biryini S&P500 to 2854 by 2013 (gain of 124%  or 31% annualized)

Pretcher stocks (he said Dow down 90%) so S&P500 to 128 by 2017 (loss of 90% or -28% annualized)

Shiller S&P500 to 1430 by 2020 (gain of 12%  or 1% annualized)

Interestingly enough, if you use the lowest (5) and highest values (45) for the Shiller P/E Ratio you get to values similar to the forecasts at both ends (300 and 2500).  I think the most interesting but unlikely forecast is all three being correct!

Hmmm! Pretty useful data huh? Jeff adds this little gem in his post;

Readers interested in an actual analysis of past predictions should check out the Guru grades at CXO Advisory.  (Prechter 24%, Biryini 51%).

Random coin tosses are about as accurate as the best forecasters. So, are forecasts pretty much useless as this seems to indicate? Yep. You got it. James Montier, author of The Little Book of Behavioral Investing, wrote a great piece a few years ago on the Seven Sins of Fund Management that discusses this is a lot more detail (this PDF is an expanded version of the book and its free!). In it he says;

An enormous amount of evidence suggests that we simply can’t forecast. The core root
of this inability to forecast seems to lie in the fact that we all seem to be over-optimistic
and over-confident. For instance, we’ve found that around 75% of fund managers think
they are above average at their jobs! It doesn’t matter whether it is forecasting bonds,
equities, earnings or pretty much anything else, we are simply far too sure about our
ability to forecast the future.
Given the dreadful track records that can be seen from even a cursory glance at the data,
it begs the question of why we bother to keep using forecasts? Let alone putting them at
the very heart of the investment process? (A mistake probably 95% of the investment
processes I’ve come across persist in making).
The answer probably lies in a trait known as anchoring. That is in the face of uncertainty
we will cling to any irrelevant number as support. Little wonder, then, that investors
continue to rely on forecasts. (emphasis mine)

I couldn’t agree more. And I think every investor needs to have a way to deal with these behavioral issues. My investment process takes care of most of these issues for me. I don’t invest in market indexes so I could honestly care less about the forecasts for those indexes. Secondly, I invest in dividend payers and as I’ve posted on before, over a period of 5 years or so, investment performance is almost entirely a function of the dividend yield and dividend growth. Simple. Lastly, my investment goals are NOT tied to market performance at all. My primary goal is to generate absolute returns on my portfolio at low risk that allow me to meet my conservative retirement spending goals. I spend most of my investment time looking at the fundamentals of the businesses I invest in and how that impacts their dividend and dividend growth prospects. Which leads me back to the question mark in the title of this post.

I do have an outlook or expectation for my stock holdings. I also have opinions on what current world wide market and asset class valuations are saying about the probabilities of future performance. I guess some would call that a forecast but not in the explicit sense of calling out year end valuations. To me its a probabilistic outlook that informs my investment positioning and risk exposure. Having said all that here is my outllook for my major stock holdings:

These are returns an investor could reasonably expect if buying the securities at the start of 2011. Some of these stocks are long term holdings for me and thus the expected return for me would be my yield on cost plus the 2011 dividend growth. For example, my yield on cost on EPD is about 10% so my expected return for 2011 is about 15%. The dividend growth estimates are either directly from the company’s public 2011 plans or a conservative forecast based on historical dividend growth rates. In a later post I will comment more explicitly on current MLP valuation. For my stealth dividend stock, FFH, I just use management’s stated, and most often beat, goal of compounding book value at 15% annually.

As far as the macro environment goes, it mainly drives my asset allocation decisions. And those decisions are strongly colored by my contrarian nature. Today I find markets in general over valued world wide based on historical relationships with emerging markets being frothier than developed ones. And more importantly I think there are more risks to the downside than surprises to the upside. In that light in the new year I have raised my cash position to about 40% of my portfolio. I think there is a good probability that 2011 will give me a chance to put that cash to work. But maybe not. Who knows?

I short, I think my portfolio is well positioned for good absolute returns in 2011 while limiting my downside risk. Continued early retirement looks to be a strong probability this year. But hey…I’m not forecasting am I???