"Never make predictions, especially about the future."
-- Casey Stengel.
In late December in each of the past five years, I have taken a page from former Morgan Stanley strategist Byron Wien -- and now the chief investment strategist at Pequot Capital Management -- and prepared a list of possible surprises for the coming year.
These are not intended to be predictions but rather events that have a reasonable chance of occurring despite the general perception that the odds are very long. I call these "possible improbable" events.The real purpose of this endeavor is to consider positioning a portion of my portfolio in accordance with outlier events -- with the potential for large payoffs. After all, Wall Street research is still very conventional and based on "groupthink," despite the reforms over the past several years. Mainstream and consensus expectations are just that, and in most cases they are deeply embedded into today's stock prices. If I succeed in at least making you think about outlier events, then the exercise has been worthwhile. Almost half of last year's predicted surprises actually transpired, up from one-third in 2006 and from 20% in 2005. Nearly one-half of the prognostications proved prescient in 2004 and about one-third in the first year of surprises in 2003.
But it wasn't the quantity of the correctly predicted surprises that made 2007's list a remarkable success, it was the quality, as I hit on nearly every major variant theme: the severity of the housing depression, the turmoil and writedowns in the credit markets, the curtailing of private-equity deals and the reawakening of equity market volatility. Consider just a couple of these quotes from our Surprise List for 2007 :
- "A fractured mortgage market leads to a standstill in deal-making as the capital markets (and underwriting activity) seize up."
- In early 2007, "evidence of cracks in subprime credits are ignored, with housing-related equities soaring to new 52-week highs by March 1. However, a dumping of homes on the market in the spring serves to result in a quantum increase in the months of unsold housing inventory and a dramatic drop in the average home price. ... Sales of existing and new homes take another sharp leg lower as we enter what I've dubbed the Great Housing Depression of 2007. Importantly, the financial intermediaries that source mortgage financing/origination begin to feel the financial brunt of the Great Mortgage Bubble of 2000-06 after years of creative but nonsensical lending behavior."