John Mauldin
Dec 31, 2014
It’s that time of year when people start thinking about New Year’s resolutions and investment planning for the future. It’s also the time of year when analysts feel more or less compelled to offer up forecasts. My friend Doug Kass turns the forecasting process on its head by offering 15 potential surprises for 2015 (plus 10 also-rans). But he does so with a healthy measure of humility, starting out with a quote from our mutual friend James Montier (now at GMO):
(E)conomists can't forecast for toffee ... They have missed every recession in the last four decades. And it isn't just growth that economists can't forecast; it's also inflation, bond yields, unemployment, stock market price targets and pretty much everything else ... If we add greater uncertainty, as reflected by the distribution of the new normal, to the mix, then the difficulty of investing based upon economic forecasts is likely to be squared!
Lessons Learned Over the Years
"I'm astounded by people who want to 'know' the universe when it's hard enough to find your way around Chinatown." – Woody Allen
There are five core lessons I have learned over the course of my investing career that form the foundation of my annual surprise lists:
1. How wrong conventional wisdom can consistently be.
2. That uncertainty will persist.
3. To expect the unexpected.
4. That the occurrence of black swan events are growing in frequency.
5. With rapidly-changing conditions, investors can't change the direction of the wind, but we can adjust our sails (and our portfolios) in an attempt to reach our destination of good investment returns.
Quoting from a very eclectic group of names, Doug does indeed give us a few surprises to think about, and I pass his thoughts on to you as this week’s Outside the Box. (Doug publishes his regular writings in RealMoneyPro on theStreet.com.)
As a bonus, and as a thoughtful way to begin the new year, we have a letter that my good friend and co-author of my last two books Jonathan Tepper wrote to his nephews. He began penning it on a very turbulent plane ride that he was uncertain of surviving. It made him think hard about what was really important that he would want to pass on to his nephews. As the song goes, I found a few aces that I can keep in this hand. I think you will too.
His letter made me think about what I want to be passing on to my grandchildren, including the newest one, Henry Junior, who showed up less than 24 hours ago. They are going to grow up in a very different world than the one I grew up in, and I mostly think that’s a good thing. But the values that I hope can be passed on don’t change. Good character never goes out of fashion.
My associate Worth Wray came down with a very nasty bug this past weekend, so he missed his deadline for delivering his 2015 forecast to you. We’re giving him a few more days and will run it this weekend – which also of course gives me a little more time to mull over my own forecast.
Taking to heart James Montier’s quote above, I’m going to forgo the usual 12-month forecast and look farther out, thinking about what major events are likely to come our way over the next five years. I actually think that approach will be for more useful for our longer-term planning.
Thanks for being with me and the rest of the team at Mauldin Economics this past year; and from all of us, but especially from me, we wish you the best and most prosperous of new years.
You’re staring hard at crystal balls analyst,
John Mauldin, Editor
Outside the Box
15 Surprises for 2015
Doug Kass, Seabreeze Partners
Dec. 29, 2014 | 8:12 AM EST
Stock quotes in this article:
It’s that time of year again.
"Never make predictions, especially about
the future."
– Casey Stengel
By means of background and for those new to Real
Money Pro, 12 years ago I set out and prepared a list of possible surprises for
the coming year, taking a page out of the estimable Byron Wien's playbook. Wien
originally delivered his list while chief investment strategist at Morgan
Stanley, then Pequot Capital Management and now at Blackstone. (Byron Wien's
list will be out in early January and it will be fun to compare our surprises.)
It takes me about two to three weeks of thinking
and writing to compile and construct my annual surprise list column. I
typically start with about 30-40 surprises, which are accumulated during the
months leading up to my column. In the days leading up to this publication I
cull the list to come up with my final 15 surprises. (Last year I included five
also-ran surprises.)
I often speak to and get input from some of the
wise men and women that I know in the investment and media businesses. I have
always associated the moment of writing the final draft (in the weekend before
publication) of my annual surprise list with a moment of lift, of joy and
hopefully with the thought of unexpected investment rewards in the New Year.
This year is no different.
I set out as a primary objective for my surprise
list to deliver a critical and variant view relative to consensus that can
provide alpha or excess returns.
The publication of my annual surprise list is in
recognition that economic and stock market histories have proven that (more
often than generally thought) consensus expectations of critical economic and
market variables may be off base.
History demonstrates that inflection points are
relatively rare and that the crowds often outsmart the remnants. In
recognition, investors, strategists, economists and money managers tend to
operate and think in crowds. They are far more comfortable being a part of the
herd rather than expressing – in their views and portfolio structure – a
variant or extreme vision.
Confidence is the most abundant quality on Wall
Street as, over time, stocks climb higher. Good markets mean happy investors
and even happier investment professionals.
The factors stated above help to explain the
crowded and benign consensus that every year begins with, whether measured
either by economic, market or interest-rate forecasts.
But an outlier's studied view can be profitable
and add alpha. Consider the course of interest rates and commodities in 2014,
which differed dramatically from the consensus expectations.
To a large degree the business media perpetuates
group-think. Consider the preponderance of bullish talk in the financial press.
All too often the opinions of guests who failed to see the crippling 2007-09
drama are forgotten and some of the same (and previously wrong-footed) talking
heads are paraded as seers in the media after continued market gains in recent
years.
Memories are short (especially of a media kind).
Nevertheless, if the criteria for appearances was accuracy there would have
been few available guests in 2009-2010 qualified to appear on CNBC, Bloomberg
and Fox News Business.
Indeed, the few bears remaining are now
ridiculed openly by the business media in their limited appearances, reminding
me of Mickey Mantle's quote, "You don't know how easy this game is until
you enter the broadcasting booth."
Abba Eban, the Israeli foreign minister in the
late 1960s and early 1970s once said that the consensus is what many people say
in chorus, but do not believe as individuals.
GMO's James Moniter, in an excellent essay
published several years ago, made note of the consistent weakness embodied in
consensus forecasts.
As he put it:
"(E)conomists can't forecast for toffee ...
They have missed every recession in the last four decades. And it isn't just
growth that economists can't forecast; it's also inflation, bond yields,
unemployment, stock market price targets and pretty much everything else ... If
we add greater uncertainty, as reflected by the distribution of the new normal,
to the mix, then the difficulty of investing based upon economic forecasts is
likely to be squared!"
Lessons Learned
Over the Years
"I'm astounded by people who want to 'know'
the universe when it's hard enough to find your way around Chinatown." – Woody Allen
There are five core lessons I have learned over
the course of my investing career that form the foundation of my annual
surprise lists:
1. How wrong conventional wisdom can consistently be.
2. That uncertainty will persist.
3. To expect the unexpected.
4. That the occurrence of black swan events are growing in
frequency.
5. With rapidly-changing conditions, investors can't change the
direction of the wind, but we can adjust our sails (and our portfolios) in an
attempt to reach our destination of good investment returns.
"Let's face it: Bottom-up consensus
earnings forecasts have a miserable track record. The traditional bias is
well-known. And even when analysts, as a group, rein in their enthusiasm, they
are typically the last ones to anticipate swings in margins." – UBS (top 10
surprises for 2012)
Let's get back to what I mean to accomplish in
creating my annual surprise list.
It is important to note that my surprises are
not intended to be predictions, but rather events that have a reasonable chance
of occurring despite being at odds with the consensus. I call these
possible-improbable events. In sports, betting my surprises would be called an
overlay, a term commonly used when the odds on a proposition are in favor of
the bettor rather than the house.
The real purpose of this endeavor is a practical
one – that is, to consider positioning a portion of my portfolio in accordance
with outlier events, with the potential for large payoffs on small
wagers/investments.
Since the mid-1990s, Wall Street research has
deteriorated in quantity and quality (due to competition for human capital at
hedge funds, brokerage industry consolidation and former New York Attorney
General Eliot Spitzer-initiated reforms) and remains, more than ever,
maintenance-oriented, conventional and group-think (or group-stink, as I prefer
to call it). Mainstream and consensus expectations are just that and, in most
cases, they are deeply embedded into today's stock prices.
It has been said that if life were predictable,
it would cease to be life, so if I succeed in making you think (and possibly
position) for outlier events, then my endeavor has been worthwhile.
Nothing is more obstinate than a fashionable
consensus and my annual exercise recognizes that, over the course of time,
conventional wisdom is often wrong.
As a society (and as investors), we are
consistently bamboozled by appearance and consensus.
Too often, we are played as suckers, as we just
accept the trend, momentum and/or the superficial as certain truth without a
shred of criticism. Just look at those who bought into the success of Enron,
Saddam Hussein's weapons of mass destruction, the heroic home-run production of
steroid-laced Major League Baseball players Barry Bonds and Mark McGwire, the
financial supermarket concept at what was once the largest money center
bank, Citigroup (C),
the uninterrupted profit growth at Fannie Mae and Freddie Mac, housing's new
paradigm (in the mid-2000s) of non-cyclical growth and ever-rising home prices,
the uncompromising principles of former New York Governor Eliot Spitzer, the
morality of other politicians (e.g., John Edwards, John Ensign and Larry
Craig), the consistency of Bernie Madoff's investment returns (and those of
other hucksters) and the clean-cut image of Tiger Woods.
My Surprises for
2014
These generally proved in line with my historic
percentages.
"How'm I doin'?" – Ed Koch,
former New York City mayor
While over recent years many of my surprise
lists have been eerily prescient (e.g. my 2011 surprise that the S&P 500
would end exactly flat was exactly correct), my 15
Surprises for 2014 had a success rate of about 40%, about in line with what
I have achieved over the last 11 years.
As we entered 2014, most strategists expressed a
constructive economic view of a self-sustaining domestic recovery, held to an
upbeat (though not wide-eyed) corporate profits picture and generally shared
the view that the S&P 500 would rise by between 8-10%.
Those strategists proved to be correct on profit
growth (but only because of several non-operating factors and financial
engineering), were too optimistic regarding domestic and global economic growth
and recognized (unlike myself) that excessive liquidity provided by the world's
central bankers would continue to lift valuations and promote attractive market
gains in 2015. Not one major strategist foresaw the emerging deflationary
conditions, the precipitous drop in the price of oil and the broad decline in
domestic and non-U.S. interest rates.
Many readers of this annual column assume that
my surprise list will have a bearish bent (to be sure that is the case for
2015). But I have not always expressed a negative outlook in my surprise list.
Two years ago my 2012 surprise list had an out-of-consensus positive tone to
it, but 2013's list was noticeably downbeat relative to the general
expectations. I specifically called for a stock market top in early 2013, which
couldn't have been further from last year's reality, as January proved to be
the market's nadir. The S&P closed at its high on the last day of the year
and exhibited its largest yearly advance since 1997. (I steadily increased my
fair market value calculation throughout the year and, at last count, I
concluded that the S&P 500's fair market value was about 1645.)
As I said, in 2014 my success rate was at about
40% (which included five also-ran predictions).
This contrasted with my 15 surprises for 2013,
which had the poorest success rate since 2005's list (20%).
By comparison, my 2012 surprise list achieved
about a 50% hit ratio, similar to my experience in 2011. About 40% of my 2010
surprises were achieved, while I had a 50% success rate in 2009, 60% in 2008,
50% in 2007, 33% in 2006, 20% in 2005, 45% in 2004 and 33% came to pass in the
first year of my surprises in 2003.
Below is a report card of my 15 surprises for
2014 (and the five also-ran surprises).
Surprise No. 1: Slowing global
economic growth. RIGHT
Surprise No. 2: Corporate profits
disappoint. HALF RIGHT (as financial engineering buoyed EPS).
Surprise No. 3: Stock prices and
P/E multiples decline. WRONG
Surprise No. 4: Bonds outperform
stocks. Closed-end municipal bond funds are among the best asset classes,
achieving a total return of +15%. VERY RIGHT
Surprise No. 5: A number of major
surprises affect individual stocks and sectors. (Starbucks (SBUX) falls,
3D printing stocks halve in price, General
Motors (GM) drops by 20% in 2014). MORE WRONG THAN RIGHT
Surprise No. 6: Volkswagen AG acquires Tesla Motors (TSLA).
WRONG
Surprise No. 7: Twitter's (TWTR) shares fall
by 70% as a disruptive competitor appears. MORE RIGHT THAN WRONG
Surprise No. 8: Buffett names
successor. WRONG
Surprise No. 9: Bitcoin becomes a roller coaster. RIGHT
Surprise No. 10: The Republican Party
gains control of the Senate and maintains control of the House. Obama becomes a
lame duck President incapable of launching policy initiatives. RIGHT
Surprise No. 11: Secretary Hillary
Clinton bows out as a presidential candidate. WRONG
Surprise No. 12: Social unrest and
riots appear in the U.S. RIGHT
Surprise No. 13: Africa becomes a
new hotbed of turmoil and South Africa precipitates an emerging debt crisis.
HALF RIGHT
Surprise No. 14: The next big thing? A
marijuana IPO rises by more than 400% on its first day of trading. WRONG
Surprise No. 15: An escalation of friction
between China and Japan hints at war-like behavior between the two countries.
WRONG
Also-Ran Surprises: Crude oil trades
under $75 a barrel (short crude and energy stocks) RIGHT, VIX trades under 10
(short VIX) RIGHT, gold trades under $1,000 (Short GLD) DIRECTIONALLY RIGHT.
What Was the
Consensus for 2014 and What Is the Consensus for 2015?
"The only thing people are worried about is
that no one is worried about anything ... That isn't a real worry." – Adam Parker,
chief U.S. strategist at Morgan Stanley
"In ambiguous situations, it's a good bet
that the crowd will generally stick together – and be wrong." – Doug Sherman and
William Hendricks
As mentioned earlier, we entered 2014 there was
a generally upbeat outlook for global economic and profit growth, as well as
upbeat prospects for the U.S. stock market. Projections for bond yields were
universally for higher yields throughout the year and the same could be said
for the general expectation of rising oil prices. As is typical, most
sell-side projections for earnings, the economy, bond yields and stock prices
were grouped in an extraordinarily tight range.
·
Both U.S. and global economic growth
disappointed the consensus (despite a strong third-quarter 2014 U.S. GDP
number).
·
S&P earnings were a slight beat,
but only because of more-aggressive-than-anticipated share repurchase programs,
lower depreciation and interest expenses and a decline in effective tax rates.
·
Bond yields declined unexpectedly.
The 10-year yield dropped to about 2.2% from 3.05%.
·
Deflationary forces were also a
surprise, most notably no one projected that oil prices would fall to under $60
s barrel and that the Bloomberg Commodity Index would hit a five-year low in
December, 2014.
·
Stock prices ended the year about 5%
above beginning-of-the-year consensus forecasts.
Virtually all strategists are now self-confident
bulls, as gloom-and-doom forecasts have all but disappeared. After another year
with no reactions of 10% or more, any future setbacks are being viewed by the
consensus as bumps in the road and as opportunities to buy because (after the
correction(s)) we will be up, up and away."
After missing the 25% rise in valuations in 2013
(and a further expansion in P/E ratios in 2014), the consensus now assumes that
valuations will expand slightly again in 2015. (Note: The average P/E ratio has
increased by about 2% per year over the last 25 years.)
The domestic economy has forward momentum (as
witnessed by +5% Real GDP growth in 3Q 2014), so the extrapolation of heady
growth is now in full force by the consensus.
In terms of the markets, the consensus remains
of the view that liquidity (albeit, at a slowing rate) will overcome
complacency and valuations again as it did last year, but my surprises
incorporate the notion that the extremes that exist today (in price and bullish
sentiment) put the markets in a different and less secure starting point in
2015.
"We expect the growth recovery to broaden
as global growth picks up to 3.4% in 2015 from 3% in 2014. Inflation is likely
to remain low, in part due to declines in commodity prices, and as a result
monetary policy should remain easy. We think this backdrop supports a pro-risk
asset allocation." – Goldman Sachs, Global Opportunity Asset Locator
(December 2014)
As we enter 2015, investors and strategists are
again grouped in a narrow consensus and expect a sweet spot of global economic
corporate profit growth that will translate to higher stock prices.
The consensus is for U.S. economic growth of
+2.5% to +3.25% real GDP, bond yields to be 50-75 basis points higher than
year-end 2014 and closing 2015 stock market price targets to be up by about
8-10% (on average). Indeed, most strategists suggest (in sharp contrast to
their views 12 months ago) that the big surprise for 2015 will be that there is
upside to consensus economic growth and stock market price targets.
Here were Goldman Sach's views for 2014 made 12
months ago (with actual in parentheses). As can be seen, the brokerage's growth
forecasts for the real economy (as was the entire sell side) were too
optimistic, while price targets for the S&P were not ambitious enough:
·
U.S. real GDP was estimated at +3.1%
for 2014. ( +2.4%A)
·
Global real GDP was estimated
at+3.6% for 2014. (+3.0%A)
·
S&P 500 EPS $116 top-down
estimate and $119 bottom-up estimate for 2014 ($119/shareA)
·
Year-end S&P 2014 S&P 500
price target was estimated for 2014 at 1900 (2080A)
·
Inflation/headline CPI +1.5% for
2014. (+1.1%A)
·
U.S 10-year Treasury yield 3.25% for
year-end 2014. (2.20%A)
Again, let's use Goldman Sachs' principal 2015s
views of expected economic growth, corporate profits, inflation, interest rates
and stock market performance as a proxy for the consensus for the coming year.
This year the brokerage, like most, is following the bullish trend and is more
optimistic on the market relative to its uninspiring expectations last year.
·
2015/2016 U.S. real GDP +3.1%, +3.0%
·
2015/2016 global real GDP +3.6%,
+3.9%
·
2015 S&P 500 operating per share
profits $122/share
·
Year-end 2015 S&P 500 price
target 2100
·
2015/2016 Consumer Prices +1.0%,
+2.4%
·
2015 closing yield on the U.S.
10-year Treasury note 3%
The Rationale
Behind My Downbeat Surprises for 2015
There are numerous reasons for my downbeat theme
this year. In no order of importance: corporate profit margins remain elevated,
the rate of domestic economic growth is decelerating (despite five years of QE
and ZIRP), a quarter of the world is experiencing minimum growth in GDP,
optimism and complacency are elevated, signs of malinvestment are appearing,
valuations (P/E ratios) rose again after a 25% expansion in 2013 (compared to
only +2% annual growth since the late-1980s. As well, so many gauges of
valuations are stretched (market cap/GDP, the Shiller P/E ratio and many
others).
Above all, I expect the theme of the U.S. as an
oasis of prosperity will be tested in 2015-16 as contagion might be a bi**h.
Moreover, given the large array of potentially
adverse economic, geopolitical and other outcomes, the markets have grown
complacent after a trebling in prices over the last five years.
Finally, my downbeat surprises this year
recognize, that as we enter 2015, we should not lose sight of the notion that
if pessimism is the friend of the rational buyer, optimism is the enemy of the
rational buyer.
My 15 Surprises
for 2015
At last, here are my 15 surprises for 2015 (with
a strategy that might be employed in order for an investor to profit from the
occurrence of these possible improbables).
Surprise No.1 – Faith in central bankers
is tested (stocks sink and gold soars).
"Investment bubbles and high animal spirits
do not materialize out of thin air. They need extremely favorable
economic fundamentals together with free and easy, cheap credit and they need
it for at least two or three years. Importantly, they also need serial pleasant
surprises in such critical variables as global GNP growth." – Jeremy Grantham
"The highly abnormal is becoming
uncomfortably normal. Central banks and markets have been pushing benchmark
sovereign yields to extraordinary lows – unimaginable just a few years back. Three-year
government bond yields are well below zero in Germany, around zero in Japan and
below 1 per cent in the United States. Moreover, estimates of term premia are
pointing south again, with some evolving firmly in negative territory. And as
all this is happening, global growth – in inflation-adjusted terms – is close
to historical averages. There is something vaguely troubling when the
unthinkable becomes routine." – Claudio Borio
European QE Backfires: The ECB initiates
a sovereign QE in January 2015, but it is modest in scale (relative to
expectations) as Germany won't permit a more aggressive strategy. Markets are
disappointed with the small size of the ECB's initiative and European banks
choose to hold their bonds instead of selling. ECB balance sheet still can't
get to 3 trillion euros and the euro actually rallies sharply. Bottom line, QE
fails to work (economic growth doesn't accelerate and inflationary expectations
don't lift).
Draghi Is Exposed: Mario Draghi is
exposed for what he really is: the big kid of which everyone is scared. For
some time, no one wanted to fight him (or fade sovereign debt bonds, which
would be contra to his policy). But, after the meek January QE, the response
changes. He is now seen as the bully who never throws a punch and who always
has gotten his way. But at the time of the January QE a medium-sized kid (and a
market participant) teases him and Draghi warns him again to stop it. The kid
keeps teasing. Draghi the bully takes a swing, it turns out he can't fight and
the medium-sized kid whips his butt. From then on, the big kid is feared no
more. For some time Draghi has said he will do "whatever it takes,"
but he never really had to do anything. When he finally gets going and has to
act rather than talk, he will expose himself as only a bully and as a weak big
kid. Mario Draghi gets fed up with the Germans and returns to Italy (where he
was governor of the Bank of Italy between 2006-2011) and becomes the country's
president.
Shinzo Abe and Haruhiko Kuroda
Resign: Kuroda,
an advocate of looser monetary policy, stays on at the Bank of Japan (for most
of the year), but the yen enters freefall to 140 vs. the dollar and wage growth
lags badly. Japanese people have had enough and, by year end, Prime Minister
Shinzo Abe and Haruhiko Kuroda are forced to resign.
The Fed Is Trapped: The Federal
Reserve surprises the markets and hikes the federal funds rate in April 2015. A
modest 25-basis-point rise in rates causes such global market turmoil that it
is the only hike made all year. The Federal Reserve is now viewed by market
participants as completely trapped, as an ah-ha-moment arrives in which there
is limited policy flexibility to cope with a steepening downturn in the
business cycle in late 2015/early 2016. Stated simply, the bull market in
confidence in the Federal Reserve comes to an abrupt halt.
Malinvestment Becomes the It-Word in
2015: Steeped
in denial of past mistakes and bathing in the buoyancy of liquidity and the
elevation of stock prices in 2014, market participants come to the realization
that the world's central bankers in general, and the Fed in particular, once
again has taken us down an all-too-familiar and dangerous path that previously
set the stage for The Great Decession of 2007-09. It becomes clear that the consequences
of unprecedented monetary easing and the repression of interest rates has only
invited unproductive investment and speculative carry trades. The impact of a
lengthy period of depressed interest rates uncork malinvestment that has
percolated and detonates among differing asset classes as the year progresses.
Already seen in the deterioration and heightened volatility in commodities (the
price of crude, copper, etc.), in widening spreads in the energy high yield
(with yields up to 10% today, compared with only 5% a few months ago) and with
the average yield on the SPDR
Barclays High Yield Bond ETF (JNK) up to 7% (from a low of
5% earlier in 2014), the consequences of financial engineering
(zero-interest-rate policy and quantitative easing) and lack of attention to
burgeoning country debt loads and central bankers' balance sheets, in addition
to inertia on the fiscal front result in rising volatility in the currency
markets.
Malinvestment in countries like Brazil (where consumer debt has risen
by 8x and export accounts have quintupled over the last eight years on the
strength of a peaking export boom, in oil and iron ore, so dependent on the China
infrastructure story that has now ended) translate in to a deepening economic
crisis in Latin America and in other emerging markets.
Then, EU sovereign debt yields, suppressed so
long by Draghi's jawboning, begin to rise. Slowly at first and then more
rapidly, EU bond prices fall, putting intense pressure on the entire European
banking system. (In his greatest score, George Soros makes $2.5 billion
shorting German Bunds). The contagion spreads to other region's financial
institutions. Shortly after, social media and high valuation stocks get routed
and, ultimately, so does the world's stock markets.
As a result of the influences above, the VIX
rises above 30. The price of gold soars to $1,800-$2000 and the precious metal
is the best-performing asset class for all of 2015.
Strategy: Buy GLD and VIX, Short SPY/QQQ and
German Bunds
Surprise No. 2 – The U.S. stock market
falters in 2015.
"In a theater, it happened that a fire
started offstage. The clown came out to tell the audience. They thought it was
a joke and applauded. He told them again and they became more hilarious. This
is the way, I suppose, that the world will be destroyed – amid the universal
hilarity of wits and wags who think it is all a joke." – Soren
Kierkegaard.
Market High Seen in January, Low Seen in
December (at Year End): The U.S. stock market experiences a 10%+
loss for the full year. (Note: Not one single strategist in Barron's Survey is
calling for a lower stock market in 2015. Projected gains by the sell side are
between +6-16%, with a median market gain forecast at +11%). The S&P Index
makes its yearly high in the first quarter and closes 2015 at its yearly low as
signs of a deepening global economic slowdown intensify in the June-December
period.
While earnings expectations disappoint, the real
source of the market decline in 2015 is a contraction in valuations
(price-earnings multiples) after several years of robust gains. Investors begin
to recognize that low interest rates, massive corporate buybacks, the
suppression of wages, phony stock option accounting and other factors
artificially goosed reported earnings and that earnings power and organic
earnings are less than previously thought. So, 2015 is a year in which the
relevant ways of measuring overvaluation (market cap/GDP currently at 1.25 vs.
0.70 mean) and the Shiller CAPE ratio (currently at 27x vs. 17x mean) become,
well, relevant.
With few having the intestinal fortitude to
maintain skepticism and short positions into the unrelenting bull market of
2013-14, there is none of the customary support of short sellers to cover
positions and soften the market decline, when it occurs.
Stocks begin to drop in the first half, well
before the real economy tapers, underscoring the notion (often forgotten) that
the stock market is not the economy.
But by mid-year it becomes clear that U.S.
economic growth is unable to thrive without the Fed's support.
Year-over-year profits for the S&P decline
modestly in the second half of 2015. Domestic Real GDP growth falls to under
+1.5% in the third and fourth quarters.
By year end the market begins to focus on The
Recession of 2016-17, which looms ahead in the not so distant future.
Strategy: Short SPY
Surprise No. 3 – The drop in oil prices
fails to help the economy.
"In its November 14, 2014 Daily
Observations ("The Implications of $75 Oil for the US Economy"), the
highly respected hedge fund Bridgewater Associates, LP confirmed that lower oil
prices will have a negative impact on the economy. After an initial transitory
positive impact on GDP, Bridgewater explains that lower oil investment and
production will lead to a drag on real growth of 0.5% of GDP. The firm noted
that over the past few years, oil production and investment have been adding
about 0.5% to nominal GDP growth but that if oil levels out at $75 per barrel,
this would shift to something like -0.7% over the next year, creating a
material hit to income growth of 1-1.5%." – Mike Lewitt, The
Credit Strategist
Despite the near-universal view that lower oil
prices will benefit the economy, the reverse turns out to be the case in 2015
as the economy as a whole may not have more money – it might have less money.
Continued higher costs for food, rent,
insurance, education, etc. eat up the benefit of lower oil prices. Some of the
savings from lower oil is saved by the consumer who is frightened by slowing domestic
growth, a slowdown in job creation and a deceleration in the rate of growth in
wages and salaries.
And the unfavorable drain on oil-related capital
spending and lower-employment levels serve to further drain the benefits of
lower gasoline and heating oil prices.
In The Financial Times, recently, Martin Wolf
wrote: "(A) $40 fall in the price of oil represents a shift of roughly
$1.3 trillion (close to 2 per cent of world gross output) from producers to
consumers annually. This is significant. Since, on balance, consumers are also
more likely to spend quickly than producers, this should generate a modest
boost to world demand."
But Wolf, and the many other observers, as Mike
Lewitt again reminds us, "fail to explain how the $1.3 trillion that has
been deducted from the global economy is able to shift from one group to
another. "
Surprise No. 4: The mother of all flash
crashes.
"America is the 'arch criminal' and
'unchangeable principal enemy' of North Korea." (Dec. 22, 2014)
"America is a 'toothless wolf' and 'the
empire of devils."" (March 27, 2010)
"North Korean missiles will reduce
Washington, D.C. to 'ashes.'" (August 19, 2014)
"America is a 'group of Satan' bent on
destroying Korean religion." (April 22, 2013)
"American 'ideological and cultural poisoning'
is undermining socialism around the world." (July 16, 2014)
– Selected quotes from North Korea's
state-controlled media
Hackers attack the NYSE and Nasdaq computer
apparatus and systems by introducing a flood of fictitious sell orders that
result in a flash crash that dwarfs anything ever seen in history.
In the space of one hour the S&P Index falls
by more than 5%.
The identity of the attacker goes unknown for
several days and it turns out to be North Korea.
Strategy: Buy VIX, Short SPY/QQQ
Surprise No. 5: The great three-decade
bull market in bonds is over in 2015.
"Take then thy bond thou thy pound of
flesh..." –
Portia, The Merchant of Venice
Last year not one strategist saw lower interest
rates (though that was my No. 1 Surprise last year). This year, not one
strategist expects a spike in interest rates.
In the first half of 2015, European yields and
U.S. yields start to converge, in that European yields begin to jump to where
the U.S. 10-year yield resides. The failure of Draghi's policy (see Surprise
No. 1) will result in an acceleration in the European debt yields rising and in
a decay in debt prices. That will mark the end of the great three-decade bond
bull market in the U.S. and it will occur as global growth eases.
Strategy: None
Surprise No.6 – China devalues its
currency by more than 3% vs. the U.S. dollar.
"It's not like I'm anti-China. I just think
it's ridiculous that we allow them to do what they're doing to this country,
with the manipulation of the currency, that you write about and understand, and
all of the other things that they do." – Donald Trump
For years, China has essentially pegged it's
currency to the U.S. dollar. (liberalization meant that a narrow trading range
is permitted). With the huge run in the U.S. Dollar, China's currency has
appreciated compared with other Asian currencies. As a result, China has lost
its manufacturing edge and its trade surplus has all but disappeared. Whether
it's a permitted day-to-day weakening, changing the peg from the dollar to a
basket of currencies or whether there is an overnight surprise devaluation,
China's currency will weaken materially in 2015.
Strategy: None
Surprise No. 7 – Apple (AAPL) becomes the
first $1 trillion company.
"There's an old Wayne Gretzky quote that I
love. 'I skate to where the puck is going to be, not where it has been.' And
we've always tried to do that at Apple. Since the very, very beginning. And we
always will."
– Steve Jobs
Apple's next generation iPhone is seen to likely
outsell its latest phone iteration as Re/Code uncovers (and reveals) some
amazing and unique new features/applications that are planned for the next
generation phone.
I don't know what features it will have or how
it will improve design or performance. But I think there is now a near-consensus
that it won't and that the next product upgrade cycle is a while away.
So, I predict Apple 2016 estimates rise
significantly (to $10/share) and, despite a weak market backdrop, Apple becomes
the first $1 trillion dollar market-cap company and the best-performing
large-cap in 2015.
Apple becomes the only one-decision stock during
the stock market swoon during the last half of 2015. It is a must own.
Strategy: Buy APPL
Surprise No. 8 – Legislation is
introduced that allows for repatriation for foreign cash.
"The only difference between death and
taxes is that death doesn't get worse every time Congress meets." – Will Rogers
As signs of domestic economic growth fade in the
second half of 2015, Congress and the Administration agree on a broad program
to repatriate foreign cash at a low tax rate.
The deal briefly rallies the U.S. stock market,
but equities soon succumb to a slowing domestic economy and diminishing
corporate profit growth.
Strategy: None
Surprise No. 9 – Energy goes from the
worst-performing group in 2014 to the best-performing group in the first half
of 2015 and then falls back later in the year.
"Oil vey!" – Kass Daily Diary term
Energy stocks are on a roller coaster in 2015.
As the price of crude oil rises steadily
(towards $65 a barrel) in early 2015, the energy sector (which was among the
worst in 2014) becomes the best market group in the first half of the year.
Slowing global economic growth during the last half of the year leads to
profit-taking in the energy sector as the price of crude oil closes the year at
under $50 and at its lowest price in 2015.
In a surprise move, the president signs approval
for the Keystone Pipeline in the second half of the year.
Strategy: Buy oil stocks in first six months of
the year, sell/short mid-year.
Surprise No. 10 – More chaos in the
Democratic Party.
"Mothers all want their sons to grow up to
be president, but they don't want them to become politicians in the
process." –
John F. Kennedy
Sen. Elizabeth Warren pushes Secretary Hillary
Clinton so far to the left that she loses independent voters, though she easily
gains the Democratic nomination for president.
Former President George H.W. Bush passes away
during the first half of the year and Governor Jeb Bush immediately declares
his candidacy.
By the end of 2015, Jeb Bush is well ahead in
the polls and is a big favorite to win the presidency in 2016.
Strategy: None
Surprise No. 11 – Food inflation
accelerates after Russia halts wheat exports.
"As life's pleasures go, food is second
only to sex. Except for salami and eggs. Now that's better than sex, but only
if the salami is thickly sliced." – Alan King
Russian turmoil continues and Putin decides to
halt exports of wheat again to keep as much homeland as possible, resulting in
a price spike in wheat, but also corn and soybeans. This price rise, on top of
U.S. food inflation that is already running higher, offsets the consumer
benefit of still-relatively-low gasoline and heating oil prices.
Strategy: None
Surprise No. 12 – Home prices fall in the
second half of 2015.
"I told my mother-in-law that my house was
her house and she said, 'Get the hell off my property.'" – Joan Rivers
Under the weight of reduced home affordability,
still-low household formation gains and continued pressure on real incomes,
home prices fall in 2015.
Builders lose pricing power.
Strategy: Short homebuilders.
Surprise No. 13 – Individual and sector
market surprises.
"Those who are easily shocked should be
shocked more often." – Mae West
·
Bank Stocks Fall – Though bank
stocks have been recent market leaders, the weight of a flattening yield curve,
still-tepid loan demand and an implosion in the European banking system make
the sector among the worst market performers. Moreover, a major cyber attack
against Bank of
America (BAC) that actually destroys a percentage of
customer records further diminishes enthusiasm for the group.
·
Twitter Feeding – Carl Icahn,
calling it his "new Netflix," discloses a 9.9% position in Twitter.
This stimulates a bidding war between Google (GOOGL)
and Facebook (FB)
to acquire the company. Google wins the battle and pays $60 a share for
Twitter.
·
Volatility Rising – The VIX rises to
over 30 in the second half of the year.
·
Google Institutes a Share Buyback
and Shaves Capital Spending – After a lackluster performance in 2014, Google's
management reverses course on its previously outsized capital spending program
on non-core businesses and becomes more shareholder friendly. The company dials
back spending and institutes a stock buyback program.
·
Corporate Inefficiency in Large-Cap
Technology Targets Activist Investors –- Two hedge funds establish a filing
position in Cisco (CSCO)
and force Chairman John Chambers out. The new CEO announces a large special
dividend and a massive stock buyback and a cutback to the employees'
too-generous stock option plan. More than 10% of the workforce is laid off and
Cisco's shares soar. Several other tech companies are targeted.
Strategy: Long AAPL TWTR, CSCO, VIX, GOOGL and
short banks
Surprise No. 14 – Berkshire Hathaway
(BRK.A) makes its largest acquisition in history.
"When I was 15 years old, I read an articls
about Ivan Boesky, the well-known takeover trader – turned out years later it
was all on inside information! But before that came to light, he was very
successful, very flamboyant. And I thought, 'This is what I want to do.' So I'm
15 years old, I decide I'm going to Wall Street." – Karen
Finerman
During the depths of the market's swoon in the
later part of the year, Warren Buffett scoops up his largest acquisition ever.
The $55+ billion acquisition is not in his customary comfort zone (a consumer
goods company), but rather the deal is for a company in the energy, retail or
construction/equipment areas.
Strategy: None
Surprise No. 15 – A derivative blowup
precipitates an abrupt market drop.
"I view derivatives as time bombs, both for
the parties that deal in them and the economic system." – Warren Buffett
The $300 trillion holdings of derivatives by the
U.S. banking industry has been all but forgotten.
The four-largest U.S. banks account for $240
trillion of that total, dwarfing their combined $750 billion in statutory
capital! This sort of exposure in which notional derivatives are more than 300x
the banks' net worth, is, as my friend The Credit Strategist's Mike Lewitt has
written, "would be laughable if the consequences of a financial accident
were not so potentially catastrophic."
To make matters worse, the passage of the $1.1
trillion spending bill passed this month (written by lobbyists and voted on by
bought-and-paid-for legislators who probably neither read nor understood the
complex spending bill) has kept taxpayers on the hook –through the FDIC – for
those derivatives (what Warren Buffett previously called "financial
weapons of mass destruction.")
On any measure, the sheer size of these
derivative portfolios pose potential risk to the world's financial stability.
What we have learned from the past cycle is how opaque the exposure really is
and how stupid and avaricious our bankers really are when allowed to venture
into territories of leverage.
Whether it is energy derivatives or some other
asset class, a derivative blowup in 2015 will serve to preserve the wise words
of Benjamin Disraeli (who served twice as Great Britain's Prime Minister) that
"what we have learned from history is that we haven't learned from
history."
It will also harm our markets, once again.
Strategy: Short SPY
10 Also-Ran Suprises for 2015
By DOUG KASS
Dec. 26, 2014 | 7:32 AM EST
·
On Monday I will deliver my 15
Surprises for 2015. I think it is my most interesting list in years.
Here are my 10 also-ran Surprises for 2015 that
I had considered but didn't make the top 15.
1. China's Real GDP growth falls below 5% in 2015 as economic
growth decelerates markedly in the second half of the year.
2. An accounting "discrepancy" is found at Alibaba (BABA). The
shares plummet and the hedge fund community feels the pain.
3. Under pressure from suppliers and a falling stock price, Ron Johnson is installed as CEO
ofSears Holdings (SHLD).
4. George Soros makes $2.5 billion by shorting German
Bunds.
5. The price of crude oil drops below $40 a barrel in the
second half of 2015.
6. The consumer price index turns negative (year over year).
7. IBM (IBM) whiffs
and the share price drops below $125 a share. Berkshire Hathaway(BRK.A)
suffers a near-$4 billion loss (on paper). At Buffett's suggestion, senior
management is replaced.
8. Warren Buffett announces his successor.
9. Uber goes public at a $50 billion capitalization. The
share price never exceeds the IPO price in 2015.
10. Monitise's (MONIF)
subscription adds far outpace expectations this year. (The shares double in
price).
Letter to My Nephews
By Jonathan Tepper
December 29, 2014
You can learn a lot from books, but many things
can only be learned the hard way by living, suffering and enjoying life.
A year and a half ago, I was in a plane with
very bad turbulence, and I worried that if the plane went down, many of the
lessons I’ve learned in life would end up at the bottom of the ocean. I
wrote a letter to my nephews for them to read when they were older. I
hope they’ll find it useful.
—————–
Dear nephews,
I’m writing this on a plane. The reason I
started writing this was that I feared the plane might go down, and if it went
down, all the lessons I’ve learned in life would disappear with me. By writing
this, I hope to pass on the few lessons I’ve learned.
The most important lesson is that the vast
majority of things you worry about will not bother you the next day. A year
later you will not even be able to remember them if you try. When you grow
older, you will not worry about what grades you got. You won’t worry about
games you lost. You won’t worry about what other people thought
about you. Most of the things you worry about will never happen.
Even if the
worst things that you worry about happen, life will still go on. Learn to enjoy
every day, and try to enjoy it as if it is your last. It has taken me a long
time to understand this, and I wish I had understood it sooner.
Happiness is not a destination but a journey.
You will never be smart enough, rich enough, have a pretty enough girlfriend,
boyfriend, husband or wife, or win enough prizes and awards. Whatever it is you
want, there is always something better. Enjoy the journey of learning, working,
and living. If you enjoy the journey, you’ll probably achieve a lot more than
if you focused on goals.
Money can provide security, but once you have
security, more money cannot buy you more happiness. If you show me someone who
thinks money can buy happiness, I’ll show you someone who has never had a lot
of money.
Things don’t make you happy, but memories will
always stay with you. Whatever it is that you buy, you will soon get used to
it. It will make you happy for a short while, but it will not make you happy
forever. Experiences and memories can make you happy forever. I can’t even
remember most of the toys I’ve had in my life, but I still think of my times
with Timothy and your Grandmom with great happiness and fondness. I remember
walking Timothy to school and how happy we were. I remember hugging your
Gradmom when I came home for a weekend. Those memories will never go away. The
happiest memories of my friends are my travels and dinners with them, not the
things I’ve bought for myself. You’ll remember dinners and travels with friends
and family more than any shiny things you’ll ever have.
Your family is the most important thing you have
in life. Friends, boyfriends, girlfriends and co-workers come and go, but the
only thing that you can always count on is your family. (If you find a friend
who is always there for you, you’re extremely lucky. They exist, but they’re
very rare.) One day, you will have your own family. You must love them and look
after them. You will understand one day that just as your grandparents die,
your parents will as well. Strive to be a good son and daughter. One day, you
will be like your parents. Your parents are not perfect, and you will not be
either. But you can be loving and be a good son and daughter. One day you can
be a good parent.
Never stop learning, and always be ready to
teach yourself things you don’t know. The only things you will remember are
things you care about. You will forget about all the rest. You must teach
yourself and care about what you learn. No one can teach you everything you
need to know at school or university. You will also forget most of what you
study, and that is fine. As Jacques Barzun said, “Civilization is all that
remains after you have forgot all that you specifically set out to remember.”
Never live someone else’s life. Find your gifts
and the things that give you pleasure, develop those gifts, and pursue
them. Do what makes you happy and be great at it. You have skills
and gifts that no one will ever have or see again. If you’re a businessman,
build businesses. If you’re a writer, write. If you’re a scientist, discover.
If you do what you love and love what you do, you will work very hard, but you
will enjoy every day.
One of the things that most influenced me was
something Steve Jobs once said:
When you grow up, you
tend to get told that the world is the way it is and your life is just to live
your life inside the world, try not to bash into the walls too much, try to
have a nice family life, have fun, save a little money.
That’s a very limited
life. Life can be much broader once you discover one simple fact, and that is
that everything around you that you call life was made up by people that were
no smarter than you. And you can change it, you can influence it, you can build
your own things that other people can use. Once you learn that, you’ll never be
the same again.
And the minute that you
understand that you can poke life and actually something will, you know if you
push in, something will pop out the other side, that you can change it, you can
mold it. That’s maybe the most important thing. It’s to shake off this
erroneous notion that life is there and you’re just going live in it, versus
embrace it, change it, improve it, make your mark upon it.
I think that’s very
important and however you learn that, once you learn it, you’ll want to change
life and make it better, cause it’s kind of messed up, in a lot of ways. Once
you learn that, you’ll never be the same again.
I hope that you will find what you love and you
will change the world.
Life is full of struggle, and many bad things
will happen to you. This is one thing that I can guarantee you. Most of my
friends died of AIDS, and your uncle Timothy died in a car accident and your
Grandmother committed suicide after suffering from a very bad brain tumor.
These things happened and cannot be changed. Many people suffer great tragedies
and live full and happy lives. Remember the people you love and mourn them.
Accept that terrible things happen, and try to live as if each day is your last
with those you love. There is nothing else you can do.
The best way to avoid anxiety, stress and
unhappiness is to avoid internal contradiction. Don’t think that one thing is
right and do the opposite. Listen to your conscience and obey it. Be a good
person and live according to your convictions. You cannot answer for other
people, but you can always answer for yourself. As long as you live according
to your most basic beliefs, you will not have regrets or guilt. You will be
able to die happily knowing that you looked after the poor and needy, that you
were loving to those around you, and that you failed often but did your best.
You will not lose a night of sleep if you always try to do your best.
I love you very much.
Much love,
Uncle Jonathan
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