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Third Quarter Update on 2011's Sure Things

As promised, here's our third update of the eight sure bets for 2011. Keep in mind if they're sure things, they should all come true. We will give a score of + for a forecast that came true, a - for one that was wrong, and a 0 for a tie.

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China We begin with China being the best place to invest. The SPDR S&P China ETF (GXC) closed 2010 at 76.24 and ended the third quarter at 55.81, a price only loss of about 26.8 percent. (Including dividends, the loss would be about 25 percent.) Vanguard's index funds had following returns:
  • S&P 500 -- -8.8 percent
  • Small caps -- -15.5 percent
  • Small-cap value -- -16.8 percent
  • Large-cap value -- -10.2 percent
  • Real estate -- -5.8 percent
  • Developed markets -- -15.8 percent
  • Emerging markets -- -23.4 percent
In other words, it underperformed all the major equity asset classes. Score - (Score 0+/1-)

Photo courtesy of Dainis Matisons on Flickr.

Large-cap Stocks The second sure thing was that this was going to be the year of large-cap stocks. Since large-cap stocks outperform small-cap stocks about 40 percent of the time, this isn't much worse than a coin flip - and if gurus keep predicting it will happen, they'll eventually get it right. Until the third quarter, small caps were outperforming. However, with the financial crisis and the ensuing bear market, large caps have outperformed small caps by almost 7 percent year-to-date. Score + (Score 1+/1-)

Photo courtesy of redwood 1 on Flickr.

The third sure thing was that all of the monetary stimulus would cause the rate of inflation to take off. The CPI rose in seven of the first eight months of the year: 0.4 percent, 0.5 percent, 0.5 percent, 0.4 percent, 0.2 percent, -0.2 percent, 0.5 percent and 0.4 percent. For the past 12 months the CPI has risen 3.8 percent. However, the core rate (which excludes food and energy) has increased just 2.0 percent for past 12 months. The core is a much better predictor of future inflation due to the high volatility of food and energy prices. Only time will tell if that holds true in this case.

However, it is important to note that oil prices have fallen sharply - WTI crude began the year at over $91 and ended the quarter below $80. Bottom line, the rate of inflation has picked up a bit, but has certainly not taken off. We'll give this a score of zero, as at least the direction was correct. Score 0 (Total Score +1/-1)

Interest Rates
The fourth was that interest rates would rise substantially. The 10-year Treasury rate actually fell, from 3.36 percent at year-end to just 1.92 percent at the end of September. Score - (Total Score +1/-2)

Photo courtesy of ralphunden on Flickr.

Municipal Bonds
The fifth was that there would be a massive wave of defaults on municipal bonds, with Meredith Whitney calling for "50 to 100" sizeable muni defaults in 2011, totaling about $100 billion. In 2010, 82 deals failed to pay on just $2.7 billion in bonds (and most of these defaults were on project-specific bonds, non-rated bonds or junk bonds, the kind we recommend you avoid). As my Alternative Investments co-author Jared Kizer has noted, state and local governments have taken dramatic actions to prevent Whitney's forecast from coming true. And so far this year there have been few defaults. Municipal defaults have dropped this year to about $1.1 billion, a quarter of last year's total. Looks like, Whitney's forecast will go down alongside BusinessWeek's 1979 forecast of "The Death of Equities" as one of the worst of all time. Score - (Total Score +1/-3)

Photo courtesy of EnergeticNYC on Flickr.

The sixth sure thing was that the price of gold would continue to soar. It ended 2010 at $1,406 an ounce and closed Sept. 30 at $1,622, an increase of 15.3 percent. Score + (Total Score 2+/3-)

Photo courtesy of covilha on Flickr.

The seventh sure thing that actually happened was that the price of oil would rise to well over $100 a barrel. Brent crude ended the year at around $99 a barrel and closed the third quarter at around $102, a slight increase. However, as mentioned earlier, WTI crude has fallen significantly. We'll call this one a tie. Score 0 (Total Score 2+/3-)

Photo courtesy of sjorford on Flickr.

Stockpicker's Year The last sure thing was that 2011 will prove to be a stockpicker's year. We don't have a scorecard for the quarter, so we have to rely on the first half review. According to Morningstar, only 31 percent of large-cap funds have outperformed their relative benchmarks in the first six months of 2011, even lower than the historical six-month average of 41 percent. This performance occurred despite the recent collapse in the correlation of individual stocks. The measure has dropped by more than 25 percent since hitting a 23-year high last July. The rising correlation was the excuse active managers were giving last year. This time they have to think of another, and next year there will be another, and so on. The reason they have to come up with new excuses each year is, as William Sharpe put it: "Properly measured, the average actively managed dollar must underperform the average passively managed dollar, net of costs. Empirical analyses that appear to refute this principle are guilty of improper measurement."

That leaves us with just two of eight sure things for 2011 having actually occurred. Not a very good track record for "sure things." My long experience in the markets, including running trading rooms for some of the largest institutions in the U.S., has taught me that all crystal balls are cloudy, including my own. As Warren Buffett said: "A prediction about the direction of the stock market tells you nothing about where stocks are headed, but a whole lot about the person doing the predicting."

We will provide a wrap-up at the end of the year.

Photo courtesy of yomanimus on Flickr.
More on MoneyWatch:
How Are 2011's Sure Things Faring at Mid-Year? How Did the "Sure Things" Fare in 2010? 9 Bits of Conventional Wisdom You Should Ignore How to View the Current Economic Situation John Bogle's Dream Fund
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