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Newsletter – 2013 Predictions
My name is Max
Rudolph. I consult with companies on enterprise risk management 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. Check back
late in the year when I analyze what actually happened. 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. 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 having input on topics, corporations should send $1,000
and individuals $100 in US currency payable to
Rudolph Financial Consulting, LLC
5002 S. 237th Circle
Elkhorn, NE 68022 USA
The newsletters are distributed via
email, so please include an active email address.
You can also follow me on twitter at
maxrudolph.
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!
General happenings.
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 wake up.
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
- Space junk knocks out
a satellite used for TV/phone transmission
- 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
- Fracking is declared
illegal due to environmental impact
- China erupts in civil
war
- Greece or Germany
leaves Eurozone
- Venezuela erupts in
violence, shutting down their oil industry
- A virus develops drug
resistance and becomes transmissible by air
- War erupts in Asia
with battles over resources, with China the aggressor
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.
- Immigration reform:
both political parties will reach out to Hispanics through legislation
to set up the 2016 election.
- 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 1426. 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.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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 an option.
- 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 worse.
- 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.
Emerging Risks - Concerns
- Levees in California,
earthquakes/volcanos, water poisoning of NYC, cyber hackers.
- Infectious disease -
increased resistance to antibiotics (e.g., tuberculosis, staff
infections or pneumonia).
- Global warming –
unexpected side effects like new viral/bacterial attacks, along with
coastal flooding, increased hurricane activity and shifting weather
patterns that impact farming.
- 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.
- 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.
- 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
Top Actuarial Issues
- Defined benefit plan
valuation – valuation methods need to be revamped.
- 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.
- 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 available.
- 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 scenario
- 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
Warning and disclaimer: The information provided in this newsletter is the
opinion of Max Rudolph and is provided for general information only. It
should not be considered investment advice. Information from a variety of
sources should be reviewed and considered before decisions are made by the
individual investor. My opinions may have already changed, so you don’t want
to rely on them. Have fun!
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