Kass: Grading and Updating My Surprises

"I don't want to make the wrong mistake."

--Yogi Berra

As successful as the 2007 surprise list was, our 2008 list has proven to be even more accurate. Like the Dark Knight's newest Batman, there was a touch of demon in the market's stealthy menace and engrossing tragedy over the first six months of the year. As it is said, action is the antidote of despair, and attention to the 2008 surprise list could have saved investors quite a bit of money (especially by avoiding the finance sector). At our halftime intermission, here are my grades and updates for my surprises for 2008:

1. The Housing Depression of 2007 morphs into the Retail Spending Depression of 2008. Stubbornly high inflation coupled with a deceleration in the rate of job growth, which turns into job losses by midyear, and an absence of innovation (a creativity void in consumer electronic products and apparel), leads to an unprecedented and abrupt drop in personal consumption expenditures.

The Retail HOLDRs (RTH Quote) exchange-traded fund declines to $80 from $94. Despite their apparent "value" today, retail stocks, especially women's apparel, are among the worst-performing stocks in the first half of 2008.

Grade A+: The Retail HOLDRs declined a swift $10 during the first two weeks of January, rallied back to almost $99 and now stands in the high eighties. More importantly, the evidence suggests that the housing problem has clearly begun to negatively affect personal consumption and retail stocks have been among the worst-performing market sectors in the latest selloff.

Going forward, I see no reason to alter this surprise. Indeed, the RTH could breach the $80 mark to the downside. While current retail cash flow multiples of 5 times to 6 times appear low and ripe for a rally, the 2008 to 2010 EBITDA expectations might prove to be too optimistic given the plight of the American consumer.

2. Under pressure from slowing consumer spending, disappointing capital spending and higher commodities, corporate profits drop by 10% in 2008. Importantly, the pattern of economic activity grows increasingly inconsistent and lumpy, providing a difficult backdrop for corporate managers and investment managers to navigate.

Grade A+: During the last few months, corporate profit forecasts have been dramatically reduced in the face of slowing retail sales, lower-than-expected capital spending and higher input costs. Depending upon the series one is using, the first half of 2008 produced about a 5% increase in profits.