Likely improbables for 2005

Each year, fund manager Doug Kass steals (Morgan Stanley’s) Byron Wien’s list of unlikely events — 25 possible surprises — for the following year.

The surprises are not predictions, but instead represent long shot events with a better than expected chance of occurring — despite generally low public beliefs in their liklihood.

Call them variant perceptions

Doug notes "I have long felt that developing a variant view (read: surprise) remains an integral part of differentiating one’s investment returns. Mainstream and consensus expectations are just that, and, in most cases, are deeply imbedded in today’s stock prices." 

Kass:  "The real purpose of this endeavor was to consider positioning a portion of my portfolio in some part based on outlier events — with large payoffs. After all, Wall Street research is still very much convention and groupthink, despite the reforms over the past several years. If I succeed in making you think about outlier events, the exercise has been successful. "

I couldn’t agree more . . .

Here is his list of possible surprises in 2005:

1. After a lackluster holiday retail season, the consumption binge of the last decade comes to an abrupt halt. Retail sales turn negative and home prices plummet (first on the East and West coasts, then in the rest of the country) while (cost-push) inflation accelerates. The mini-panic of 2005 occurs — during a two-day period the stock market drops by 9% — as stagflation concerns surface.

2. U.S. equity prices drop by double-digit percentages in the first half of 2005 and, unlike 2004, show no recovery, after the initial drop, for the balance of the year.

3. The Japanese Nikkei is among the best-performing equity markets in the world; the London market is among the worse performing equity markets.

4. In the face of a precipitous drop in the U.S. dollar (with the Euro briefly trading at 1.55!), the Federal Reserve drops its gradualist approach to monetary policy. Taking a tune from the Fed’s moves in May and November of 1994), the Fed tightens by 50 basis points and, then by 75 basis points on two consecutive Fed meetings.

5. 2005 brings another large-scale, Long Term Capital-like failure precipitated by an astonishingly large derivative loss that three major U.S. and overseas money center banks are partially on the hook for.

6. Europe sinks into a recession in the second quarter; the U.S. sinks into a recession in the fourth quarter.

7. After a brief move back above $50/barrel, crude oil trades back to under $30/barrel as demand slackens in the face of a worldwide economic slump.

8. There are no major terrorist acts in the U.S. However, England is the target of a surprise contamination of that country’s water supply by al Qaeda. Equity markets in England are closed for a 10-day period and the price of agricultural commodities rises dramatically (reminiscent of 2004’s rise in the price of crude oil).

9. The Administration imposes a national sales tax in an unsuccessful attempt to balance the budget. In the face of a worldwide downturn, the tax is repealed within six months.

10. Warren Buffett raises Berkshire Hathaway’s (BRKa) stake in Coca-Cola (KO) to 13% by purchasing (in a private transaction) all 122 million shares owned by SunTrust (STI). Berkshire Hathaway goes on a buying spree as equities tumble. Berkshire acquires Dow Jones & Company (DJ) at $58.50/share and two troubled publicly-held reinsurers.

11. Citigroup’s (C) Bob Rubin takes over the reins at AIG (AIG) from Hank Greenberg who retires.

12. The junk bond market records its worst performance in over a decade and underperforms almost every asset class in 2005.

13. The gold market records the best performance of any asset class in 2005, briefly touching $575/ounce.

14. Housing stocks make nominal new highs as interest rates decline, but a series of order disappointments and guidedowns for 2006 make this sector among the worst performing areas of the U.S. equity market as the inventory of unsold homes rises parabolically.

15. A sub-prime lender or sub-prime insurer fails.

16. A computer hacker causes a serious virus which infects a large portion of the Internet causing a several week long problem at Amazon (AMZN), Google (GOOG), eBay (EBAY), Yahoo! (YHOO), AOL and many other sites.

17. Democratic aspirant Al Gore re-emerges on the political scene. New York Senator Hillary Clinton announces her intention not to enter the 2008 Presidential race. Both former President Clinton and Chelsea Clinton announce their candidacies for political offices. Late in the year, Tom Ridge announces his intention to seek the Republican nomination for the 2008 Presidential election.

18. Time Warner (TWX) sells its AOL division to Marc Cuban in a leveraged buyout after the company settles SEC and DOJ charges and as subscriber defections moderate.

19. AOL founder Steve Case re-emerges on the corporate scene as the CEO of an Internet startup which goes public and records the largest percentage rise in history of any initial public offering on its first day of trading.

20. Tyco (TYC) embarks on a series of high-profile acquisitions.

21. The SEC’s experiment in eliminating the downtick rule is abandoned coincident with the double-digit decline in stock prices during the first half of 2005.

22. There is a major accounting irregularity (spring loading earnings) uncovered in a highly regarded industrial conglomerate famous for its acquisitive appetite. Larry Summers leaves his post as president of Harvard University and becomes chairman of this troubled company.

23. Sumner Redstone gives Howard Stern permission to leave Infinity Radio earlier than his contractual responsibility and Sirius Satellite Radio briefly trades at $10/share. However, subscription levels at Sirius fail to reach expectations and the stock halves.

24. HMOs become the new focus of New York Attorney General Eliot Spitzer.

25. The New York Jets win the Super Bowl, the University of Illinois wins the NCAA Basketball Tournament and the New York Yankees capture the World Series. Pete Rose is elected to the Baseball Hall of Fame and Barry Bonds is barred from baseball for steroid use.

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