Secrets Of Success: Tough new year to call, but don't listen to experts

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It is, sadly, far too early for cowards like me to start making firm predictions for the year ahead. As regular readers will recall, the most successful technique for forecasting the direction of markets that I have found useful involves treating the consensus predictions of other pundits as a contrarian indicator to what lies ahead.

It is, sadly, far too early for cowards like me to start making firm predictions for the year ahead. As regular readers will recall, the most successful technique for forecasting the direction of markets that I have found useful involves treating the consensus predictions of other pundits as a contrarian indicator to what lies ahead.

This is a technique I shamelessly cribbed from the American money manager Ken Fisher. It has logic and history to support it, although it is by no means infallible. And by definition, given that the New Year is the time when every man and his dog is required to pontificate about the year ahead, the results take time to be collated. As a result this column's New Year typically arrives several weeks after everyone else's.

Discounting the prevailing level of consensus wisdom was certainly strong enough to make me confident there would be a recovery in the stock markets in the year just gone, though the precise timing of the turn, in March, was unknowable. (I was also bolstered because several of the most thoughtful and trustworthy investors I know started to put their own money into the stock markets on a reasonable scale around that time.) For the present, my crystal ball remains unusually murky, which leads me to conclude that no great radical shifts in asset allocation are needed, though on past form that will change at some point during the year.

One worry about using predictions as a forward indicator is that there are an increasing number of surveys about professional investment opinion, and it must be unlikely that they represent the considered opinion of those involved. Much more reliable is what professional investors are doing, rather than what they say they expect to do, a statistic I see at least one big global asset management firm is trying to measure, using academic theory. It will be interesting to see how it performs.

The last State Street Associates survey, just before Christmas, suggested that on the basis of actual portfolio decisions, professional investor confidence, which they argue is the primary moving force behind the direction of the markets, continues to rise and is now at its highest level for some time. Quibbles about methodology aside, I think that this is the case, though for many fund managers the feeling may in part simply reflect relief that they are still holding down overpaid jobs after the traumas of the previous three years.

Most fund managers appear to be looking forward to continued strong economic growth in 2004, led by the US, where easy money remains the policy du jour and there is still an election to be won or lost (don't discount a Bush victory at this stage). Strong growth and a slow return to tighter monetary conditions, if both assumptions prove to be well founded, should be conducive to another reasonable year in the stock markets, where appetite for risk has been steadily returning since the lows of last March. This in turn is reflected in the glaring fact that 2003 was a year when junk did better than quality in almost every market.

But I am sure I am not the only one who has noticed there is something of a contradiction in the assumptions that underlie the comfortable prognosis, and the validity of the "low interest rate, strong growth" thesis will therefore need carefully watching. If growth can be maintained at its present above-trend rate, which is by no means yet certain, there is a risk that the cycle of interest rates will tighten harder and faster than most investors seem to be assuming.

True, the signals from the US suggest the Federal Reserve is doing its normal job of (how should we put this?) accommodating the electoral ambitions of the incumbent President, while adopting a more than relaxed attitude to the continued decline of the dollar.

I think the hardest call of the year is going to be what is going to happen to interest rates across the whole term structure. I do not yet have a feel for that, except to say that if bond yields rise further and more quickly than the market expects, it will present interesting options for those who rightly focus on real (after inflation) returns. At present, the case for bonds still looks thin, and I see no evidence that the US stock market is not still significantly overvalued on fundamental grounds. Other markets remain more attractive on a valuation basis.

The other big issues for the New Year seem what happens to commodities, where I suspect the growing consensus that they could be entering a new secular bull market will for once be right, and, more immediately for UK investors, the continued conundrum about where property prices are heading over the medium term. (In some ways the more interesting question is where are they now?) What I don't detect are signs of bubbles developing in any major asset class, but no doubt these will emerge, and probably out of a clear, blue sky, as normally happens.

I have also been monitoring the statistics about fund sales and industry profitability. The latest figures from the Investment Management Association, the fund industry's trade body, show corporate bonds continue to be heavily pushed by direct-sales forces and intermediaries. Experience suggests that where the sales forces are most busily shifting stock is rarely the best place to put your money, and frequently the worst. But general equity funds are again more back at the top of the list of best sellers, though net sales are running well below the excep tional years of 1999 and 2000.

A less surprising statistic from the last McKinsey survey of European fund management performance, is that the British fund management industry continues to spend more on marketing than almost any other country in Europe, one reason why its profitability is now the lowest. Many firms have cut costs in response to the continued bear market, but costs in general continue to rise. Consequently the average fund management firm is now, for the first time in many years, reporting similar levels of profitability to the rest of the financial services industry.

The lesson for investors remains as true as ever. Not only is it imperative to monitor the costs of any investment vehicle you are persuaded to purchase, you also need to monitor very carefully whether the service you are getting is worth what you are paying for.

jd@intelligent-investor.co.uk

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