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[video] Doug Kass: 15 Surprises for 2014 (Part 1)

Stocks in this article: AAMC BAC SBUX AMZN GS GM


My 15 Surprises for 2014

This year I have reduced the length of the commentary in my surprise list, which got too verbose.

As I did last year, following each surprise, I have included a specific strategy that might be employed in order for an investor to profit from the occurrence of these "possible improbables."

Below are my 15 surprises for 2014 (and five also-rans that didn't make the list).

Surprise No. 1: Slowing global economic growth and fears of stagflation emerge.

At the core of this year's surprise list is that the U.S. economy disappoints (with domestic real GDP growing at +1.75% or less, half the expected rate offered by the consensus) relative to consensus expectations. Many (e.g., Harvard's Martin Feldstein) are worried about the economy overheating, but global growth also fails to meet forecasts (and is only +2.5% against consensus forecasts of +3.6%+).

The case for slowing growth is not necessarily quartered and dependent on rising interest rates. Rather, central to my surprise is a "spent-up not pent-up" consumer whose fragility may be exposed and an uptick in economic inequality as trickle-down policy grows increasingly ineffective.

The recent rise in unemployment claims, higher gas prices, slowing population growth, the higher costs of health care, slowing retail sales and a pause in domestic automobile and housing activity likely presage that slowing growth is in store for 2014.

U.S. real GDP growth is under 2%, and worldwide growth is under 3%, making the difference between anemic growth and recession increasingly one of semantics. (Note: The U.S. stock market has a forward P/E ratio of nearly 17 with a 2% real GDP growth rate, while China has a forward P/E ratio of about 7.5x with a 7% real GDP growth rate.)

The Fed's tapering will be put on hold in response to slowing growth, and some within the Fed, including Whirlybird Janet Yellen, argue for increased levels of quantitative easing. Half the Fed members are reluctant to add "more cowbell," however, so there is no additional QE and the new Fed Chair's more aggressive monetary policy views are repudiated.

Pressure is placed on both parties in Washington, D.C., to introduce more radical and aggressive fiscal policies in order to stimulate domestic economic growth by year-end.

Major droughts in the U.S., Brazil and Russia have a knock-off impact on much higher commodity and food prices, experiencing a greater-than-5% rise in 2014 (negatively impacting the consumer's purchasing power).

The drought brings on stagflation concerns. Other supply disruptions fuel some cost-push commodity price inflation even though economic growth is weak relative to expectations.

The risk of an exogenous shock expands, and further downgrades of global growth could put the U.S. and Europe in a deflationary headlock, finding both regions in a light liquidity trap.

Even though interest rates grind a bit higher in early 2014, the rise is mild, and the yield on the 10-year U.S. note spends most of the year between 2.5% and 3.0%.

Surprisingly (with a stable rate picture), the housing market is further disrupted. Mortgage rate and home price sensitivity are underestimated, as double-digit home price increases in 2013 dwarf modest rises in incomes. As a result, affordability suffers, and real buyers are priced out of the market. Traffic and orders drop off as the year proceeds. The accumulation of homes to rent by new-era buyers (hedge funds, private equity, etc.) precipitates further weakness in the U.S. housing market -- indigestion in the rental markets develops, as there is an inability to absorb the units. By the second half of 2014, year-over-year home prices turn mildly negative.

A new homebuyer tax credit is considered in late 2014 in order to stimulate residential real estate markets.

Refinancings evaporate, serving to put pressure on household cash flow and personal consumption expenditures. The unemployment rate remains sticky (hanging around 7%), and consumer confidence falls.

The expected recovery in capital spending fails to materialize in 2014.

Companies slow down their share repurchase programs (which buoyed EPS last year), balking at higher stock prices and recognizing that the economics of debt offerings to fund repurchases are less compelling from an ROI standpoint than they were in 2013.

Strategy: Buy index puts, sell index calls, or purchase inverse ETFs.

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