Good Evening: After holding so much promise when overseas markets rose overnight, U.S. stocks spent another day drifting quietly before settling mixed. Perhaps investors are waiting for the Q4 earnings season to get underway in earnest before deciding what to do next, but the S&P 500 has rarely closed more than a point or two away from the unchanged mark of late. The lack of meaningful corrective activity in the stock market since last fall has started to breed a lack of fear. This complacency can be seen in both very low levels of bearish sentiment and the convincing break below 20 in the VIX (today’s close: 17.55). These readings almost beg for a market surprise to shake market participants out of their doldrums. Perhaps examining what surprises Blackstone’s Byron Wien thinks might be in store for our markets will be a useful exercise.
Stocks and commodities were higher overnight in the wake of strong import data in China (see below). But although the major averages and the CRB index opened with bids, enough selling materialized to take them both lower. A late rally helped stocks finish with a small flourish, and the final closes ranged from +1% (Dow Transports) to – 0.2% (NASDAQ). Except for a tiny drop in the 30 year bond, Treasurys rose and the U.S. dollar fell on Monday. The falling greenback and the steepening yield curve hinted that today’s action in those markets was less related to today’s news than it was to Friday’s weak employment report. Market strategists across Wall Street spent the day pushing out their forecasts of any Fed-induced hikes in the funds rate to later this year. The dollar index and CRB index both finished with losses of approximately 0.5%.
Anyone foolish enough to put their predictions for the coming year into print has both my sympathy and my respect. Blackstone’s Byron Wien, however, is a veteran prognosticator who has earned the respect of many investors over the years. He publishes a list of 10 “surprises” each January, and his latest potential surprises can be accessed below. In conflict with the consensus at the time, most of his predictions for 2009 came true. But his accuracy in any one calendar year (his long term batting average is around .500) is not the real lesson to be gained by reading his list of possible surprises. Investment outcomes that are unexpected are also not priced into the last sale for most securities. The cost of being wrong is thus limited for the contrarian investor, while the reward for being right is often high.
Below you will find Mr. Wien’s 10 surprises for 2010, as well as six more he left on the cutting room floor. In mock tribute, I’ve decided to offer an alternative “Uber Surprise” for each one of his predictions. Before anyone writes to tell me these calls are off the wall, or even offensive, please remember that they are all tongue-in-cheek predictions. I’ve already put my head on the chopping block with my 2010 preview, and the following are meant to meant to be a humorous take on standing apart from the crowd. Mr. Wien’s surprises are numbered; my Uber Surprises are numbered with a “U.S.” designation and appear in red:
Byron Wien’s “The Surprises of 2010” (my responses are in red):
1. The United States economy grows at a stronger than expected 5% real rate during the year and the unemployment level drops below 9%. Exports, inventory building and technology spending lead the way. Standard and Poor’s 500 operating earnings come in above $80
1. Executive order allows Level 3 (“marked to fantasy”) accounting to be extended throughout U.S. government, including Commerce Department and B.L.S. Level 3 GDP tops 10%; unemployment (re)rate drops to 5%, and, led by Level 3 gains for financial stocks, S&P 500 operating earnings come in above $100
2. The Federal Reserve decides the economy is strong enough for them to move away from zero interest rate policy. In a series of successive hikes beginning in the second quarter the Federal funds rate reaches 2% by year-end
2. Fed acknowledges strong economy all year, but decides to stick with ZIRP and extends QE through the Congressional elections in November
3. Heavy borrowing by the U.S. Treasury and some reluctance by foreign central banks to keep buying notes and bonds drives the yield on the 10-year Treasury above 5.5%. Banks loan more to corporations and individuals and pull away from the carry trade, thereby reducing demand for Treasuries. Obama says, The suits are finally listening
3. Heavy borrowing by Treasury does indeed drive the yield on the 10-year Treasury above 5.5%, at which point Secretary Geithner asks banks to ignore corporations and individuals in favor of funding U.S. borrowing needs via carry trades. Suits listen and again walk away with huge bonuses
4. In a roller coaster year the Standard and Poor’s 500 rallies to 1300 in the first half and then runs out of steam and declines to 1000, ending where it started at 1115.10. Even though the economy is strong and earnings exceed expectations, rising interest rates and full valuations present a problem. Concern about longer term growth and obligations to reduce leverage at both the public and private level unsettle investors
4. Complacency and boredom reign as S&P 500 rises exactly 1 point every day until it reaches 1300 in late September, whereupon “black swan” event takes S&P back below 1000 and sees VIX quadruple from August low of just above 10
5. Because it is significantly undervalued on a purchasing power parity basis, the dollar rallies against the yen and the euro. It exceeds 100 on the yen and the euro drops below $1.30 as the long slide of the greenback is interrupted. Longer term prospects remain uncertain
5. Every nation on earth (except China) works overtime to debase their fiat currencies in a vain attempt to support exports. The Mandarins in Beijing respond late in year with a proposal to link a now fully convertible yuan to a proprietary weighting of commodities contained in the CRB index
6. Japan stands out as the best performing major industrialized market in the world as its currency weakens and its exports improve. Investors focus on the attractive valuations of dozens of medium sized companies in a market selling at one quarter of its 1989 high. The Nikkei 225 rises above 12,000
6. After rising to 12,000 in 2010, the Nikkei 225 goes sideways until 2020 and Japan loses yet another decade
7. Believing he must be a leader in climate control initiatives, President Obama endorses legislation favorable for nuclear power development. Arguing that going nuclear is essential for the environment, will create jobs and reduce costs, Congress passes bills providing loans and subsidies for new plants, the first since 1979. Coal accounts for about 50% of electrical power generation, and Obama wants to reduce that to 25% by 2020
7. Above legislation is indeed proposed, but Congress dithers because Nuclear lobby is too small to make impactful campaign contributions. Iran points to Obama proposal as reason to redouble their “peaceful” pursuit of nuclear energy
8. The improvement in the U.S. economy energizes the Obama administration. The White House undergoes some reorganization and regains its momentum. In the November Congressional election the Democrats only lose 20 seats, much less than expected
8. Economic improvement actually energizes Congress to “punish the fat cats on Wall Street” by proposing transactions fees, or even an early reversal of the Bush tax cuts (retroactive to Jan. 1). Class warfare debates erupt, ending in a backlash that costs more than 100 incumbents in both chambers their seats
9. When it finally passes, financial service legislation, like the health care bill, proves to be softer on the industry than originally feared. There is greater consumer protection, more transparency, tighter restriction of leverage and increased scrutiny of derivatives, but the regulatory changes for investment bankers and hedge funds are not onerous. Trading volume and merger activity increases; financial service stocks become exceptional performers in the U.S. market
9. Financial reforms put in place are so lame as to make large financial firms more powerful and profitable than ever. Goldman Sachs and JP Morgan enter joint venture to solve fiscal woes of New York City and State by selling to various Native American tribes the rights to operate casinos in vacant Manhattan office buildings. The historical irony continues when the JV proposes to sell the Brooklyn bridge, but the deal founders when GS & JPM can’t agree which firm’s name goes on the left hand side of the tombstone
10. Civil unrest in Iran reaches a crescendo. Ayatollah Khomeini pushes out Mahmoud Ahmadinejad in favor of a more public relations adept leader. Economic improvement becomes the key issue and anti-Israel rhetoric subsides. Talks with the U.S. and Europe begin but the country remains a nuclear threat. Pakistan becomes the hotspot in the region because of the weak government there, anti-American sentiment, active terrorist groups and concerns about the security of the country’s nuclear arsenal
10. Civil unrest in Iran is crushed long before it reaches the 2009 crescendo. Ahmadinejad and the clerics continue to thumb their noses at the U.N. Security Council and dare a military response
Here are some also rans
11. China grows weary of investing indirectly in developed countries. It works out a deal where it is permitted to take large positions, including control, of United States and European companies. Technology and defense contractors are excluded. In exchange it agrees to revalue the renminbi by 5% this year and more over the next five years
— Only a microscopic chance of coming true, since neither party in Congress wants the appearance of selling out to the Chinese. China is instead likely to continue pursuing direct investments in emerging markets, especially in Africa and Latin America.
12. The health care bill passed by Congress was so watered down by compromise it has no kick: no public option, no real reform, no significant cost saving measures. As a result health care stocks, held back by profitability fears in 2009, become strong performers in 2010
— Agreed; this one stands a good chance of coming true
13. Continued concern about paper currencies drives investors to insure their financial assets with something that has endured value erosion over time. After a strong year in 2009 gold continues to rise reaching $1500 an ounce
— Agreed; too many precious metals investors actually fear the exact opposite
14. In spite of some softening of demand from the developed world and some penetration from sources of alternative energy, growing oil consumption from the emerging markets drives the price of crude to $100 a barrel
— Agreed; the process of switching to alternative energies will take time. Also, geopolitical turmoil gives energy longs a call option (i.e. supply disruptions)
15. The Chinese economic miracle continues as the country grows at a 10% real rate in 2010 fueled by more consumer spending and less saving, but minimum capital requirements for the banks are raised throughout the year to prevent the economy from overheating. Inflation becomes a serious concern of policymakers there
— The Chinese miracle probably does have further to run, though it will hit the wall one of these years
16. The world begins to recognize that the rising standard of living everywhere is going to create shortages of commodities beyond industrial materials and energy. Food becomes the focus and the price of wheat, corn and soybeans rise. Water also becomes an issue as shortages grow
— Could not agree more with this prediction, though just how widespread this recognition of long term scarcity becomes in 2010 is open to debate
I chose not to dicker with Mr. Wien’s “also ran” predictions because I agree with so many of them. Some could even be substituted for my own guesses about what 2010 might hold. Contrary opinions are valuable because they confront the consensus thinking in all of us, not to mention that potential payoffs can be rewarding. Contrarians everywhere, UNITE! Oops…strike that last one.
U.S. Stocks Advance a Sixth Day on Alcoa, Record China Imports
The Surprises of 2010 — Byron Wien, Blackstone Group