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Newsletter – 2013 Predictions (Results)
My name is Max Rudolph. I consult
with companies on enterprise risk management, investment and strategic
planning topics. I live in Omaha, Nebraska, USA, am credentialed as an
actuary and hold a CFA charter. I write a monthly newsletter and each
January I post my predictions for the year. Late in the year I review and
analyze what actually happened, including any tweets I got right during the
year. Coverage is mostly related to risk management and investments. Some
are written at a high level, dealing with the general economy, and some
cover specific topics. Most discuss issues that I am stewing over and need
to do a brain dump. I read a lot, and that impacts what I am thinking about.
The newsletters are educational in nature and do not constitute investment
advice. They are released publicly at
www.rudolph-financial.com about 6 months after they are released to
subscribers (predictions have a more timely release).
For those interested in a 12-month subscription, and
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Financial Predictions for 2013
Please remember that these predictions are for fun. If
I really knew what was going to happen, I would not share that information
with you! You must make your own personal decisions, considering your unique
financial circumstances, and not hold others (especially me) responsible for
your own financial planning. Enjoy!
Perceived stability is hiding a growing risk as debt
levels remain high, which will lead to currency wars and inflation. Sometime
soon the calm will break. It’s like we’re sitting on a dinosaur about to
The world has been positioning itself toward a tipping
point for several years. We are entering an uncertain future, but it will be
different from the present. The financial crisis and Arab Spring, along with
the continuing European debt crisis, evolving Chinese landscape, and
fracking developments, have set the stage. Political and economic
restructuring, possibly driven by climate change, will result in changing
leadership as resource availability drives the winners and losers. It
reminds me of the arguments presented by Jared Diamond in Guns, Germs and
Steel. Today he might change the title to technology, water and oil. Those
who have it will win. So what does that mean for 2013, incorporating event
interactions and unintended consequences of actions?
Economic variables are mean reverting, cycling from low
to high and back again. Bubbles and their opposite occur regularly, although
they are often hard to identify until after the fact. Some can be recognized
in advance, and risk managers don’t have to be perfect predictors to add
value. Bubbles are forming, especially in alternative asset classes as bond
yields have been set artificially low by the Fed. Here are some outlier
scenarios that I think are more likely to happen in the next several years.
- Cyber-terrorism impacts the banking system or
shuts down power stations (Results: the Target breach during the
holidays was a reminder of this risk)
- Space junk knocks out a satellite used for
- Atmospheric river hits California and dumps rain
on San Francisco for a month
- A severe earthquake hits California or St. Louis
- Mount Rainier or a super-volcano becomes active
(Results: it was reported that the super-volcano beneath Yellowstone
National Park has several times the magma previously thought)
- Fracking is declared illegal due to environmental
impact (Results: several train derailments – ND and Quebec – have kept
this issue in the forefront)
- China erupts in civil war
- Greece or Germany leaves Eurozone
- Venezuela erupts in violence, shutting down their
oil industry (Results: recent currency devaluation moving toward this
- A virus develops drug resistance and becomes
transmissible by air (Results: mild outbreak from Middle East of MERS
- War erupts in Asia with battles over resources,
with China the aggressor (Results: China has been working with African
nations for resources)
These predictions were made in January 2013.
- Politics: Prediction – President Obama will become
known as the oil president, much to his chagrin. Gun laws evolve but
don’t seem to stop massacres. The Republicans start to line up to run
for president in 2016 as Hillary Clinton fights health issues on the
democratic side. Joe Biden has no chance. The economy will improve early
in 2013 but tax increases will hold it back by the end of the year.
Watch for major problems in Venezuela, with Syria and Iran hotspots in
the Middle East. I continue to worry about the mayhem unleashed when
King Abdullah of Saudi Arabia dies. Europe continues to kick the can
down the road. They will continue to do so as long as they can, but it
will end badly. Japan has moved closer to the Endgame by launching a
currency war. Others will join in. The risk of China experiencing an
economic hard landing and consolidating around nationalism is
increasing. This could have major consequences, everything from an
internal revolt to a selloff in US Treasuries to an armed conflict. The
next major wars will start in cyber-space, but the Middle East remains
tense and any ground troops would likely be used there. A lessened
reliance on imported oil by the US due to fracking might cause China to
make a resources driven power grab.
- Politics: Results. Correct. As we look back
on 2013 from the distant future, the growth of fracking and loose
monetary policy will likely overshadow other stories, at least from the
US perspective. The way the two stories interact, lowering trade
deficits and decreasing the importance of Saudi Arabia, will have major
repercussions in the future especially as the US and China vie to be the
world leader. Unfortunately gun control is no closer now than it was a
year ago in the aftermath of the Newtown, Massachusetts massacre of
young children. School shootings seem to be so frequent that they don’t
even get reported nationally any more. It’s very sad that the gun lobby
is so powerful. Political posturing has begun for the presidential 2016
race, with Hillary Clinton the clear Democratic frontrunner and Paul
Ryan starting to show signs for the Republicans. A sign that the
Democrats are evolving in their environmental stance is the money
Clinton has accepted from fracking. The 2013 economy has outperformed my
expectations, driven by monetary stimulus that overwhelmed the fiscal
contraction from the sequester and government shutdown. This
inconsistent policy will have unknown long-term effects. The decision to
taper slowly, almost imperceptively, has been received favorably by Wall
Street but long-term leads us closer to John Mauldin’s Code Red event
(although it might delay it beyond 2014). Venezuela moved closer to
chaos with a late year currency devaluation, with the Syrian civil war
and Iran dance continuing. The revelations that the NSA collects data
from everyone is concerning but has not been handled well by the Obama
administration. I believe what was reported is common to all
intelligence services, and if a country’s leader chooses to use an
unprotected phone it seems like they are a bit naive. Europe continues
to kick the can down the road, but Japan started a currency war they
will eventually be responded to. China, with its new leadership team, is
changing paths and trying to stake out territory. There is a risk that
it will blow up, especially as they attempt to control islands also
claimed by others. The similarities between now and a century ago that
led to WWI are too many for me to be comfortable that we won’t end up in
a war somewhere. North Korea continues to be a wild card, and Asia is
general is heating up.
- Immigration reform: both political parties will
reach out to Hispanics through legislation to set up the 2016 election.
- Immigration reform: Results. Correct. Both
parties are reaching out to Hispanics and will continue to do so leading
up to the 2014 mid-term and 2016 presidential elections. With the poor
economic results of the past few years, there have been fewer
opportunities in the US so the focus will be on citizenship for
long-term alien residents rather than on keeping new immigrants out. If
there are no jobs there is less of an immigration problem.
- Stocks: As long as the Fed maintains artificially
low rates stocks will outperform other asset classes. The US consumer
has begun the deleveraging process and is ahead of other developed
countries. Although government debt remains high seemingly everywhere,
the US will outperform. Despite a strong start to the year in mid
January it will be a trader’s market and the final results will not vary
5% in either direction from here, with small losses or single digit
gains. Over the next 10 years stocks will outperform both cash and
especially bonds. Bonds at low interest rates are hard to get excited
about as we prepare to enter an era of higher inflation. It is hard to
understand why variable annuities force investors into bond funds when
their options are in the money. It seems like a mispricing is in there
somewhere. There is a slight chance of hyperinflation in the United
States. It will take a few years for inflation to develop before
suddenly appearing. Good companies to buy now are staples that can pass
on inflationary cost increases to their customers. Based on my filters
here are a few companies that appear to be undervalued based on publicly
available information (not recommendations, just ideas for further
analysis) and year-end prices: Tidewater TDW 44.68, and Johnson Controls
JCI 30.67. Both are carryovers from last year’s list. The S&P500 closed
2012 at 1,426. Full disclosure: my family owns shares in each of these
companies. None are controlling positions.
J For those interested you
can follow my portfolio at
www.tickerspy.com under maxrudolph.
- Stocks: Results. Correct on relative
direction but not level of returns. I was right that stocks would
outperform other asset classes, but the level of absolute performance
was much higher than I expected. At this point I find few equities that
pass my filter. Most are “pick and ax” companies for the oil fields like
TDW, HOS, CKH and RIG. I also like CHK. (long TDW and CHK) It appears
that a correction is likely, but a crash would be driven by government
policy and not overvaluation. The US deleveraging process has continued
except for student loans, which is a red flag for future economic
progress. The stock market could use a general correction as it is not
grossly overvalued but certainly is fully valued for most companies.
There may have been a taper delay due to the transition from Ben
Bernanke to Janet Yellen as Fed Chair. A trigger could be a spike in
interest rates or a negative event such as a major fracking accident or
earthquake. Stocks mentioned early in the year were Tidewater TDW 44.68
(59.27 on Dec 31, 35% total return), and Johnson Controls JCI 30.67
(51.30 on Dec 24, 70% total return). The S&P500 closed 2012 at 1426,
stands on December 31, 2013 at 1848.36, and had a 32.39% total return
for the year.
- Unemployment: Structural employment provides a
floor of about 6% now. We may see another wave of both private and
public layoffs, but these are more likely in 2014. The military drawdown
may impact US financials too.
- Unemployment: Results. Correct. The
unemployment rate has dropped from 7.8% in December 2012 to 7.0% in
November 2013. Some of this is from potential workers leaving the work
force and some is from the economy slowly adding jobs. Currently
Congress has chosen not to extend unemployment benefits so the 2014 rate
may drop early in the year as more leave the work force.
- Residential home market: most US regions will
continue to improve in 2013. Hardcore problem areas, like Las Vegas,
will continue to struggle to work through excess inventory. This will
free up the employment markets as well since it will be easier to move
regionally if your mortgage is not under water. Fracking will drive
markets if the industry can convince workers to move their families.
Fannie and Freddie are still a mess, and it would be a miracle to see a
solution in 2013. The trend of young and old moving in with empty
nesters will continue, much to their dismay. Watch for the Canadian
bubble to pop over the next couple of years.
- Residential home market: Results. Correct.
Most US regions improved in 2013 with entry homes leading the way as
excess inventory was worked through nationwide. Fannie and Freddie
continue to be undefined yet still a major part of the housing market.
Refinancing is now essentially done as rates move off their generational
lows. Once tapering starts and the Fed stops buying these assets this
market will need to clear. The Canadian housing bubble is getting a lot
more attention now.
- Volatility: The VIX closed 2012 at 18.02 (range
13-27). Volatility itself has been volatile over the past couple of
years. If VIX was a predictor of the future it would be higher. Known
risks include heavy personal and government debt levels. I find it
impossible to predict VIX but I think a reasonable range would be 20-25.
A single digit VIX is definitely too low and above 35 is too high, but I
see more possibilities for a higher result in 2013.
- Volatility: Results. Wrong. The VIX closed
2012 at 18.02 and on Dec 31 closed at 13.72 with an annual range of
11.05 to 22.72. This “predictor” continues to vex and confuse me. The
risks are much higher than this index shows. Much like equities, the VIX
seems to trade on emotion rather than fundamentals. Long-term plays are
probably okay to make as long as you avoid leverage.
- Oil: Oil on December 31, 2012 was about $91,
toward the middle of my long-term mean reversion rate of $80-120 range,
but volatility continues to make short term predictions very risky as
fracking comes on line. If oil prices fall below $50, political
instability in Russia and Venezuela will quickly follow. As the world
economy improves the price of oil should increase with demand. As the
technology to derive oil from shale increases supply, tensions in the
Middle East, Russia and Venezuela will try to pull prices up. Shale
results in a higher floor for the lowest prices but we could easily see
a spike this year due to uncertainty and posturing as the US reduces its
presence in the Middle East.
- Oil: Results. Correct. Oil rose during the
year from about $91 to $99 per barrel. US supply due to fracking is
keeping the WTI rate about $10 lower than Brent crude.
- Credit risk: credit spreads continue to be too low
given the risk in the system due to excessive debt. Municipal bonds
continue to chip away at results.
- Credit risk: Results. Correct. Spreads
continue to be low. Detroit’s bankruptcy hit many pension plans and
other institutional investors. Junk bonds do not pay the investor for
the excess risk accepted.
- Financial Services Consolidation: Bank
consolidation continues, driven by small and mid-sized insolvencies. A
consolidator of these banks will grow to a large size over the next few
years. Among too big to fail banks, Bank of America seems most likely to
implode. Insurance company consolidation is coming, with Europeans
looking to reduce exposure. Who will be the buyers? Private-equity or
sovereign funds seem most likely, with national institutions like China
Life also in the hunt. A federal charter is still years away from being
- Financial Services Consolidation: Results.
Right. Some insurance blocks were bought by sovereign funds and private
equity, but banks continued on their merry way. Deutsche Bank reportedly
has a 60 to 1 leverage ratio at the end of 2013. The Federal Insurance
Office report posted in late 2013 did not go as far as many expected
with regards to a federal charter and made you wonder why it took them
two years to write.
- Currency/Inflation: Japan has started a currency
war. Who will be the next participant? At YE2012 the Eur/USD exchange
rate was 1.32. The dollar should be weak, but its competitors are much
- Currency/Inflation: Results. Correct.
Abenomics has begun a path down a slippery slope that will keep the
world’s monetary policy loose for several years. The Eur/USD exchange
rate strengthened from 1.32 at the end of 2012 to 1.38 on Dec 31. This
result is intertwined with shale oil and the European crisis.
- Fed policy: low rates continue through 2013 as tax
increases will slow the economy and keep monetary policy loose. The US
is very susceptible to a large catastrophe, financial disaster, or armed
conflict. Valuation methods for defined benefit pension plans need to be
redesigned. In the meantime insurers will continue to offer to accept
the risks while interest rates are artificially depressed.
- Fed policy: Results. Correct. The recent
start of tapering is a very timid move. Our monetary policy is so loose,
and fiscal debt so high, that a shock to the system would be hard to
deal with. Sometime soon we need to reload.
Emerging Risks - Concerns
- Levees in California, earthquakes/volcanos, water
poisoning of NYC, cyber hackers. Results: cyber hackers are now
on everyone’s minds.
- Infectious disease - increased resistance to
antibiotics (e.g., tuberculosis, staff infections or pneumonia).
Results: MERS and new forms of influenza included clusters of health
professionals, generally a sign that the disease can spread through the
- Global warming – unexpected side effects like new
viral/bacterial attacks, along with coastal flooding, increased
hurricane activity and shifting weather patterns that impact farming.
Results: extreme weather continues to expand. I spent a lot of time
thinking and reading about this topic in 2013, and will defer here to
the article I wrote on Sustainability in the December 2013 issue of The
- Earthquakes and hurricanes – the US is overdue for
a major quake on the west coast and other areas not normally thought of
for seismic activity due to long dormant periods (e.g., Seattle,
Yellowstone, St. Louis, New York City) are well into their cycle. I’m
starting to worry more about at atmospheric river event in California.
Results: thank goodness it wasn’t worse this past year, but
Hurricane Haiyan, wildfires, flooding and convective storms created
their own furor.
- Malthus – too many people, not enough food – will
good intentions of the rich to save lives in the 3rd world
lead to increased systemic risk for society (mass starvation and
unstable regions) in the longer term? Are there unintended consequences
and systemic risk associated with the “giving pledge” by the rich?
Results: the IPCC report shows that scientists are statistically
certain that mankind is driving the higher temperatures, although
unintended consequences abound. The sea is absorbing more of the heat
than expected, and using 1998 as a base year has turned out to be
misleading as it was an especially warm year for its era. This is yet
another example where looking at all the data graphically can counter
those who want to lie with statistics. Population continues to
exacerbate the problem. Some estimate the earth already holds three
times as many people as is sustainable.
- Concentration risk – this will be a hot topic over
the next few years much as emerging risks have become. Whether it is
power at the top of an organization, short term liquidity, geographic
focus or silo risk focus, too much concentration in too few entities or
people is a great risk. Eventually it will take you down. This should be
a focus during strategic planning efforts. I have found that those who
have strong investing abilities choose to avoid leverage. Results:
margin debt is revisiting levels not seen since 2008. Not a good
Top Actuarial Issues
- Defined benefit plan valuation – valuation methods
need to be revamped. Results: still a problem, though municipal
plans are currently the headliners. See my November 2013 newsletter.
- Capital requirements – call it Basle, Solvency II
or PBA – regulators and practitioners aren’t compromising so we end up
with tools that don’t work. Trying to implement reserves before capital
is just crazy talk. Results: IFRS implementation is expected to
be very expensive. In the US regulators have delayed updating
assumptions around simple fixes like C-3 Phase 1 capital (for annuities)
for years and now the changes would lead to material increases in
capital requirements so expect the insurance industry to fight them.
They would have been better to encourage an earlier adoption as they
ignored the higher capital cost in their pricing.
- Product design – be sure to look at exposures if
hedges are not available.
- Obesity/smoking – how will the various drivers of
mortality and morbidity interact (some good, some bad)?
Strategic Scenario Planning
Look at scenarios qualitatively and graphically in
addition to quantitative focus. Consider a combination of several
deterministic scenarios, including one where the Wall Street tool kit is not
- Higher interest rates and inflation: grade 3% per
year until you get to 12%
- Qualitatively consider 20% inflation environment
- Flat equity markets combined with higher inflation
- Falling dollar – combine with high interest rate
- Global climate change – how will this impact your
business and suppliers
- Liquidity risk – consider your largest markets and
what would happen if they dried up or were regulated out of business.
Have you accepted risks that you thought were mitigated?
- No diversification is allowed between risks
Results: firms should include a low interest
rate scenario as they consider potential futures. Goldilocks (slow up) is a