Introduction

This is our Yearly Forecast, which includes a brief review of what happened in the previous year (versus what we thought was going to happen at the start of the year) and an outline of what we expect to happen this year. 

The beginning of a calendar year seems like a logical time to draw a line in the sand and describe our outlook for the coming 12 months. However, these forecasts are not set in stone and will be altered if required as new information becomes available. 

Year 2001 Review

The US Stock Market

Although we were long-term bearish going into 2001, the stock market still managed to surprise us on the downside. We had allowed for the possibility that 2001 would be an UP year for the S&P500 in nominal dollar terms, but were confident that it would be a DOWN year when the S&P500 was measured in terms of gold. As it turned out, the S&P500 suffered hefty losses in terms of both the dollar and gold. The overall pattern, however, adhered quite closely to what we had expected at the beginning of the year. From the 2001 Yearly Forecast: "This year's preliminary forecast for the stock market is UP into April (but with a nervous pullback in February), DOWN into September (probably giving us new yearly lows for the S&P500), and then UP into January 2002."

Currencies

Going into 2001 we were bearish on the US$ (we thought that the October-2000 peak in the Dollar Index would turn out to be THE top), bearish on the Yen, and bullish on the euro, the SF and the A$. Although the US$ was certainly much stronger than we had originally expected, thus forcing us to make some adjustments during the year, the October-2000 highs for dollar-euro and dollar-SF were not breached. Furthermore, the Dollar Index has essentially traded sideways for the past 16 months in what looks to be an extended topping process.

Bonds

We turned long-term bearish on bonds at the beginning of 2001 and forecast that bond yields (long-term interest rates) would rise over the ensuing 12 months in response to the Fed's expected efforts to re-inflate. While long-term interest rates did finish the year above where they started the year, in mockery of the Fed's record-breaking 11 cuts in official interest rates, they certainly didn't rise by as much as we had expected. Credit the strong dollar for the ability of the US to inflate with reckless abandon during 2001 while bond prices remained flat.

Gold and Gold Stocks

In the 2001 Yearly Forecast we said that aggressive rate-cutting by the Fed would lead to a rising yield spread (long-term interest rates rising relative to short-term interest rates), something that is a definite positive for gold stocks. This, amongst other things, led us to forecast that gold stocks would substantially out-perform the S&P500 during 2001. That forecast certainly came to fruition and a similar outcome (gold stocks substantially out-performing the S&P500) is likely in 2002. However, in order for gold stocks to have the 'rising-yield-spread tailwind' behind them in 2002 as they did in 2001, most of the work will need to be done at the long-end of the curve. By this we mean that a significant rise in the yield spread will need to be the result of higher long-term interest rates since short-term interest rates can't possibly fall much further (the 13-week T-Bill yield recently bottomed at around 1.5%).

Commodities

We expected commodity prices (as represented by the CRB Index) to weaken during the first half and then turn higher during the second half. This forecast was updated in September when we speculated that the ramping-down of economic growth as a result of the terrorist attacks would delay a commodity-price upturn by 2-3 months (potentially until the first quarter of 2002).

We were long-term bullish on oil and natural gas, but expected that a consolidation/correction phase would extend into the second half of the year. This forecast was also updated following the terrorist attacks to account for the likelihood of a more prolonged decline.

The Major Trends For 2002

Our Yearly Forecast is a snapshot, taken in January, of our 12-month outlook for the financial markets. We are, however, constantly checking what we think should be happening against what is actually happening with the aim of making whatever adjustments are necessary to ensure that we end up in the right place at the right time.

Below is an overview of what we expect to happen in each of the markets we follow over the coming 12 months. We haven't included much backup information in this report since the backup has already been provided, or will be provided, in our regular commentaries. 

The US Stock Market

In a nutshell, there are two major (and related) problems facing the stock market. Firstly, the current valuations of most large-cap stocks can only be justified if we are entering a prolonged period of falling long-term interest rates and rapid economic growth. Secondly, strong growth and falling interest rates are mutually exclusive in a situation where the growth is totally dependant on massive monetary and fiscal stimulus. We therefore cannot find any reason to be medium-term bullish on the general stock market (as represented by the S&P500 Index).

As explained in the 2nd January Interim Update, a return to a price-to-sales ratio that is consistent with the levels seen near all the major bear market bottoms of the past 53 years would result in the S&P500 dropping to at least 800 (a decline of around 30% from its current value). We expect the S&P500 to reach 800 this year.

In the 21st January Weekly Update we compared the current bear market with the 1929-1932 (US) and 1989-1992 (Japan) bear markets to explain why we considered the final 2 months of this year to be a likely period for a major low to occur.

We are confident that the stock market is ultimately going to trade at a much lower level, but the question we've been wrestling with over the past few weeks is: what path will the market take to get from where it is now to where it is going? Until recently we've been anticipating that the market would maintain its upward bias throughout the first quarter, but the action over the past few days has altered the expected pattern. The below chart reflects our current expectation that the market will make a low in March-April, move higher into July-August (probably spurred by definitive evidence that the economy is, in fact, recovering), and then head sharply lower into year-end in parallel with falling bond prices.

Currencies

The Dollar Index

Our currency market views were explained in detail in the 31st December Weekly Update ("Currency Market Update") and the 16th January Interim Update ("The Strong Dollar"). In summary, we've been short-term bullish on the Dollar since early-October last year and expect the Dollar to remain firm for a while longer. We did, however, turn short-term bearish on 24th January on the basis that the remaining upside in the Dollar appeared to be minimal. Our 2002 forecast is that first quarter strength in the Dollar Index will be followed by a decline to 105 by the fourth quarter (it will probably go lower, but we like to be conservative in our forecasts). 

The Yen

In late-2000, with one Dollar buying 111 Yen, we explained why we thought that one Dollar would buy 140 Yen within 1-2 years. That target is probably going to be reached before the end of March, after which we expect a sharp upward reversal in the Yen. Despite its bad start, we expect 2002 to be an UP year for the Yen as roughly shown on the below chart.

Our long-term outlook for the Yen remains bearish, primarily because we expect the Yen supply to increase at an even faster pace than the Dollar supply over the next few years. It is likely that the BOJ will eventually be forced to monetise in excess of 100 trillion Yen of bad loans to prevent the Japanese banking system from collapsing.

The Swiss Franc

We expect the SF to hold well above its 2000 and 2001 lows, even if the Dollar Index makes a marginal new high, and to trend higher from whatever low is made during the first quarter (see chart below). There is major resistance at around the 65c level, so the SF's ability (or inability) to surmount this level will give us an important clue as to whether this year's strength is part of a new long-term trend or is simply a counter-trend move within a long-term bear market. We expect the euro and the SF to move in synch with each other.

The Australian Dollar

We are moderately bullish on commodity prices taking a 12-month view and extremely bullish taking a 2-year view. If we are right about the general trend for commodity prices then the A$ should move sharply higher this year.

Bonds

Bonds and stocks have moved in opposite directions with such consistency over the past 4 years that most people now accept such behaviour as normal. However, in a normal (healthy) financial environment, stocks and bonds spend most of their time moving in the same direction. The inverse relationship that has been apparent over the past 4 years is a sign of the bubble.

The major trend for bonds remains UP (the major trend for long-term interest rates remains DOWN), but we expect this trend to be broken during 2002 in response to last year's surge in money-supply growth and this year's dollar decline. In our view, this year's biggest surprise (at least as far as the typical CNBC commentator/guest is concerned) will be that bonds and stocks will, at some point (most likely during the second half), experience large concurrent declines.

Gold and Gold Stocks

This year's forecast for gold and gold stocks is the same as last year's (we expect an UP year). In particular, gold stocks should dramatically out-perform the S&P500, with our long-standing target of 10 for the S&P500/XAU ratio being achieved during the final quarter (this target was first mentioned in the 4th December 2000 Weekly Update).

As was the case last year, gold stocks should benefit from a further widening of the yield spread (the yield on the 30-year T-Bond minus the yield on the 13-week T-Bill). However, whereas last year's increase in the yield spread occurred as a result of long-term interest rates remaining flat while the Fed drove short-term rates lower, we expect that this year's increase will result from the Fed holding short-term rates near current low levels while long-term rates move higher.

The below chart shows the expected pattern for this year.

Commodities

Our 2002 outlook for commodities was described in the 7th January Weekly Update. In summary, we are confident that commodities will perform well in 2002 relative to the S&P500, but are not so sure that commodities (as represented by the CRB Index) will provide a good absolute return this year. It is likely that the really big moves in most commodities will not begin until 2003.

Gold trades as money (meaning that its relative value is determined primarily by investment demand), not as a commodity, and is thus considered separately. Of the other commodities we are most bullish on silver, copper and natural gas. We are least bullish on oil (we expect oil to make new lows during the first half of 2002).