2007 Market Outlook: Da Bears Aren't Taking On The Bulls Just Yet

by: Saul Sterman

As we progress into 2007, it is high time I look back at 2006 and sum the year up. 2006 was an exceptionally good year for us. Maintaining the bullish course throughout the year wasn’t too difficult. In November 2006, we published a forward looking comment stating that the Dow had room to go up 600 points to 15900 in Q1 2007. Now that we are more than halfway there, it seems plausible to all.

We are still concerned about the second half of 2007. In comparison with January 2006 where we were able to grasp the general direction of the markets for the upcoming twelve months, for a while now, we have been getting mixed signals affecting the second half of the year. We are not overly concerned about the real estate recession, and have published extensively on the subject including this article published in September 2006.

We still think that Bernanke & Co. will initiate one perhaps two interest rate cuts in 2007, the first being around May, give or take a month. The Federal Reserve has done an excellent job until now and has gotten its timing so perfect that we nicknamed Mr. Bernanke “Big Ben” after the British landmark.

2007 is just as tricky as 2006. An interest rate cut before inflation is tamed, would derail the Dollar stability. Keeping current rates too long would effectively push GDP growth below the 3% mark. In normal times, a growth rate of 2.5% isn’t a dirty word. However, due to the size of the Federal deficit and knowing that the only remedy at the disposal of the Government is for the economy to grow its way out of the deficit, a 3% growth rate is required. Otherwise, we could be faced with serious Dollar erosion. By the way, Dollar stability does not mean a 1 to1 ratio with the Euro.

As for the markets in general, bears throughout 2006 and until this very day insist that they were correct. Excluding a single Roger, we haven’t seen other bears admit that they got their timing dead wrong. This reminds me of a poem written by a 7th grade student – J. Bloom:

“The gridiron was crooked!
The goalposts weren’t straight!
But otherwise my kick
was perfectly great!”

The past year also marked what we take to be a fool’s folly otherwise known as the stupendous growth in the ETF industry. Once upon a time, a savvy investor would hire a professional to pick the right mix of stocks to meet the specific unique requirements of the individual. There was only the management fee and brokers’ fees to contend with.

Today, a savvy investor is supposedly suppose to pick a money manager who then in turns picks other professionals to pick a basket of stocks that should work for a group of investors. Being that this is not a tailored made suite; the money manager has to tweak the assortment in order to get the right mix. In other words, a front load semi-individualized mutual fund. I won’t even go into the list of fees on this one.

The vast majority of ETF portfolios underperformed the S&P 500 and the Dow.

Had the market crashed, the bears would be heroes. The conventional bullish yet conservative money managers that picked stocks matching each client’s individual needs and circumstances faired a heck of a lot better.

For ETF portfolio managers, it is sort of like playing it safe – for them, not their clients. It makes no difference to this lot if the market goes up or down simply because they are sheltered by being part of a crowd. You can’t get too much Alpha nor take a tremendous beating in comparison with the markets’ average. However, if the market does crash, an ETF offers little insurance. Actually, it would probably be more difficult to unload an ETF in comparison with individual stocks in a time of crisis or panic.

There are many common misconceptions amongst investors regarding ETF's'. We suggest that you ask your money manager to earn his/her fee and build a conventional portfolio the hard way, or take your business elsewhere. If your portfolio has been underperforming the S&P 500 for the past two (or even three) years, it is time to realize that you need to stop listening to soothing words of ‘wisdom’ and explanations how safe ETF’s are, etc. Over a twenty year period, the average ETF portfolio will lag the market. It has to, due to simple mathematics. This reminds me of another poem by J. Bloom:

“Our quarterback just broke his leg.
The instant he went down,
he automatically became
the hero of our town.

Well, since I’m on the Ping-Pong team,
I really must complain,
‘cause no one ever gave a hoot
about my pinkie sprain.”

The Bears aren’t taking on the Bulls just yet. We’ll see today how they do against the Colts.