---
title: 12/13/13 – Right and Wrong
---

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# [12/13/13 – Right and Wrong](https://blog.commonwealth.com/independent-market-observer/2013/12/13/121313-right-and-wrong)

Posted by [Brad McMillan, CFA®, CFP®](https://blog.commonwealth.com/independent-market-observer/author/brad-mcmillan-cfa-caia-mai)

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This entry was posted on  Dec 13, 2013, 9:26:58 AM

 and tagged [Commentary](https://blog.commonwealth.com/independent-market-observer/topic/commentary) 

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One of the things I do every day is look back at the previous day and think about what I could have done better. Not so much how I failed (although that occasionally comes up) but whether I did the best I could, and what I could do better.

It only seems appropriate that I apply the same discipline to how I look at the world professionally. Not to either congratulate or beat myself up—I tend to do more of the latter—but to figure out if I am making systemic mistakes and to learn from them. I broadly cover two major areas here, the economy and the financial markets, so let’s look at both.

**The Economy: Broadly Right, with Interesting Pockets of Wrongness**

I can’t claim to be right on everything, but I have to say I got the economy right. In a presentation two years ago at Commonwealth’s National Conference, I pointed out that the U.S. was incredibly well positioned in almost every area of national competitiveness and that our only weakness was the deficit, which was being addressed.

Since then, the housing market has recovered along the lines I discussed, employment has come back strongly (albeit more slowly than I thought), and consumer spending has performed well. The deficit, as hoped, has declined to the point that next year we may see the debt as a percentage of GDP decline for the first time in many years. All of the positive factors have come into play and may continue to do so.

I did get some details wrong, including underestimating the ability and willingness of consumers to spend, and overestimating the wage growth that would be generated by the recovery. Fortunately, these errors pretty much cancelled each other out. Accelerating growth throughout 2013, after the fiscal cliff scare at the end of last year, has laid the groundwork for a sustained recovery, and the government’s newly discovered sense of responsibility means it is less likely to be a drag going forward.

I still expect wage growth to continue to accelerate, and, with unemployment now down at 7 percent, this looks like a better call than it was last year. Consumer income is also growing faster than spending, which suggests spending may continue to increase. Finally, consumer delevering has apparently turned around, which could provide further support for the economy. My calls hold for 2014.

**The Financial Markets: Wrong in Some Respects, but for the Right Reasons**

Like many people in this game, I was surprised by the melt-up in U.S. equity markets. I don’t think anyone expected the kind of gains we saw, and I was even more cautious than that, expecting limited upside potential.

Looking back at what I wrote, my reasons were solid—and are even more relevant today than they were then—but I underestimated the ability of the Federal Reserve to get what it wants. “Don’t fight the Fed” is a lesson I failed to really appreciate.

What makes it annoying is that I’d specifically taken that to heart in my projections for the economy as a whole, and they were better for it.

Many of the cautions I noted—profit margins at high levels, earnings not likely to increase at expected rates—actually turned out to be correct, but they were overwhelmed by investors’ willingness to pay ever-higher prices, driven by Fed-engineered low interest rates and an absence of real alternatives. This is a margin-expansion rally, not a fundamentally driven rally, and I didn’t account for that.

**Looking Ahead**

This time, I’m specifically trying to take two factors into account: the Fed’s actions and policy preferences, and retail investor psychology. I remain concerned about the fundamentals, much as I did at the end of last year, but as of right now, they’re no longer determinative.

My post the other day, [looking at the stock market for 2014](http://theindependentmarketobserver.com/2013/12/09/12913-the-stock-market-in-2014/), made a couple of key assumptions: First, that margins would remain around current levels; and second, that investors would stay in the market. Both were driven by my expectation that the Fed would continue to support the economy during the year. While I mentioned the possibility of a dip, maybe even a severe one, I didn’t include that in my final conclusions, again due to the expectation that the Fed would continue to intervene.

I incorporated the changing investor psychology into the analysis by, again, assuming they would stay the course despite any intra-year correction, but also by comparing valuation levels with the 2007 peak using the most optimistic metric, forward earnings estimates.

We will see, of course, whether this is sufficient to remedy the two factors I misjudged in 2013. No doubt there will be new errors and misses to reflect on next year.

Right now, I see two major ways I could be wrong. The first is if retail investors start moving into the market in a big way, which there are signs of. If so, we could see another melt-up, conceivably lasting through next year. Using 2007 as a guide to valuation tops, as I did, may not be enough. In 2014, we may be looking at another double-digit year. I don’t think so, but it’s certainly a possibility.

The second (and opposite) way I might be wrong is if the Fed decides to start pulling back—which seems certain, at some level—and the market takes this more to heart than now seems likely, deciding to reprice down to more historically normal valuation levels. Don’t fight the Fed can work both ways, and I’m assuming it will continue to back the markets. If that doesn’t turn out to be the case, and investors pull back, we could see a lot more downside exposure.

As 2013 ends, I’m broadly content with my analysis from 2012, even as I recognize things I could have done better. Looking forward, there’s no doubt in my mind that the country is in a significantly better place economically. My concerns about the market remain—and, in fact, are even greater—but at this point, the signs seem to point to stability or even continued gains. Caution is, however, recommended.

**On a More Personal Note**

I do my [gratitudes](http://theindependentmarketobserver.com/2013/02/19/21913-gratitude-and-loss/) every day and share some of them here on the blog from time to time. Today’s gratitude, and a big thank-you, go to my wife, Nora, who dragged 16 bags of leaves and yard waste (I just went down and counted) to the curb last night for pickup while I was playing with Jackson. Thanks, sweetheart! I’m very grateful for you in general, and my back is particularly grateful for this!

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The MSCI EAFE (Europe, Australia, Far East) Index is a free float‐adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of 21 developed market country indices.

The Dow Jones Industrial Average is computed by summing the prices of the stocks of 30 large companies and then dividing that total by an adjusted value, one which has been adjusted over the years to account for the effects of stock splits on the prices of the 30 companies. Dividends are reinvested to reflect the actual performance of the underlying securities.

The Russell 2000 is a market-capitalization weighted index, with dividends reinvested, that consists of the 2,000 smallest companies within the Russell 3000 Index. It is often used to track the performance of U.S. small market capitalization stocks.

One basis point (bp) is equal to 1/100th of 1 percent, or 0.01 percent.

The VIX (CBOE Volatility Index) measures the market’s expectation of 30-day volatility across a wide range of S&P 500 options.

The forward price-to-earnings (P/E) ratio divides the current share price of the index by its estimated future earnings.

Third-party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided on these websites. Information on such sites, including third-party links contained within, should not be construed as an endorsement or adoption by Commonwealth of any kind. You should consult with a financial advisor regarding your specific situation.

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