An Analysis of an Analyst's Predictions

Every year, Byron Wien, the U.S. strategist at Morgan Stanley Dean Witter, comes out with a list of surprises. He sets a tough standard, saying that the surprises should be genuine. His criterion: They should be viewed, generally, as a one-in-three possibility, though he believes there's a 50% chance or better that each surprise will come true. This list has become popular primarily because Wien has a tendency to be right when it comes to surprises.

Last year, for instance, he correctly anticipated aggressive Fed rate hikes and a falling stock market. He also correctly predicted the decline of Internet stocks, the jump of oil prices above $30 and the outperformance of the Russell 2000 small-cap index. Some misses: Treasury yields rising to 7.5%, McCain vs. Bradley in the presidential election and the successful restructuring of Europe.

This year's surprises anticipate recession, aggressive Fed moves and more struggles in the stock market. The list was written before the Fed moved this week, so some of the surprise sheen has already worn away. Moreover, unlike past lists, I think this one is less surprising all around. But maybe I'm just overly confident in Wien's soothsaying abilities.

So, here's a breakdown of this year's surprises:

1. Fears of legislative gridlock notwithstanding, President Bush forges a surprisingly constructive working relationship with the new Congress. Important legislation on health care, education and income tax reduction passes. A bipartisan bill to reduce estate taxes to the equivalent of the capital gains rate passes easily. Bush proves to be a "unifier" after all.

You know what, I don't think this is such a daring opening salvo from Wien. Sure, the newspapers are filled with the hue and cry of how narrowly divided the government is, but I think we underestimate how much a president can drive the agenda. Recall that Bill Clinton polled in the low 40s first time around but still managed to get his massive health care initiative pretty far down the track before it imploded. I think Bush, with more modest aims (save for the massive tax cut), will prove effective at driving piecemeal change.

2. The dollar remains surprisingly strong against the yen and the euro as the economies of other major industrialized countries sag unexpectedly in response to the weak U.S. economy. The yen-dollar exchange ratio reaches 130 and the euro sinks to 75 cents. Germans take to the streets in protest over the unworthy successor of the once-proud deutsche mark. Wim Duisenberg resigns as president of the European Central Bank and Hans Tietmeyer is called out of retirement to take the helm of the beleaguered institution.

Now this would be a surprise, especially because the Fed has started slicing rates. The euro is long overdue for a rebound, and the Fed, by cutting rates, is undermining the dollar's strength. Tietmeyer? No way, Jose. The French are aching to get the top seat at the ECB, and they're not going to let the Germans beat 'em to the punch.

3. Despite the surprising weakness in the global economy, the price of crude oil soars to $40 as the winter proves colder than expected and fuel-source inventories remain thin. OPEC increases production modestly, but strained refining and marketing capacity keeps the price of gasoline and heating oil high, leading to an outcry by consumers and regulatory authorities. Legislators are outraged but confused about what action they should take. There is a Vietnam war-type demonstration at the Strategic Petroleum Reserve.

Whoa! Byron loves his public anger. But this is folly. If you believe No. 1 surprise (Bush effective), as I do, then this administration will have a very effective energy policy out of the gate. I think the focus on energy, as well as a renewed drive for more exploration and development of oil fields puts a cap on oil prices, even if the winter is a bit more brisk this year.

4. The Japanese economy slips back into recession, even though aggressive fiscal and monetary stimulus tries to head it off. The Nikkei 225 declines and threatens to fall below the level of the Dow Jones Industrial Average.

Sometimes he cheats. The first half of this prediction can't really be termed a surprise. It'd be a surprise if Japan suddenly started shaking its booty and began growing again. But Byron saves himself with the radical Nikkei-Dow forecast. Unless the Dow puts in a monster year, this is very unlikely.

5. The U.S. economy dips into outright recession in the first half of 2001. As the unemployment rate moves up toward 5%, the Federal Reserve eases aggressively, taking the federal funds rate down by 150 basis points by midyear. Yields on the 10-year Treasury note threaten to pierce 4%. Recovery is muted in the second half of 2001 and profit surprises remain skewed toward the downside.

Again, Wien wrote this before the Fed started moving. And I think that makes this a less surprising possibility. The Fed is already headed in that direction. Recession call? A mug's game. Maybe, maybe not, though I'd wager that we don't get the two consecutive quarters of declining growth that would define a recession.

6. Instead of rising 10% as the consensus expects, Standard & Poor's 500 earnings decline because of the cost of amortizing capital equipment and servicing debt on modest growth in revenues. The indexes do not have a major rebound, but rather continue to consolidate and digest the gains of the late 1990s. The S&P 500 is up less than 10% after making a new two-year low in the spring.

The earnings piece of this is a bold statement. And if it comes true, I think the S&P 500 would be up less than 10% -- in fact, it'd probably be down for the year again.

7. Value outperforms growth in the U.S. and small- and medium-capitalization issues beat large-caps. Old Economy stocks do better than New, but at least two household names in American industry agree to mergers to avoid Chapter 11 filings.

This is an allusion to Xerox (XRX Quote - Cramer on XRX - Stock Picks), probably. That company is having a very tough time, and it would certainly qualify as a household name. One wonders, however, what the other household name might be. Would Amazon(AMZN Quote - Cramer on AMZN - Stock Picks) rise to such a qualification?

8. Consumer electronics and home improvement retailers become hot stocks in the second half of the year, led by Best Buy (BBY Quote - Cramer on BBY - Stock Picks), Circuit City (CC Quote - Cramer on CC - Stock Picks), Home Depot (HD Quote - Cramer on HD - Stock Picks) and Lowe's (LOW Quote - Cramer on LOW - Stock Picks).

Now, I wonder why this is. Some deep, gut feeling? Is Byron on a personal do-it-yourself binge? In love with the PlayStation 2? Hard to say. But if the Fed moves aggressively, as we're seeing, then the Home Depots and Lowe's of the world ought to put in a decent year.

9. The semiconductor inventory cycle turns up as the Fed's easing finally starts to work. New products associated with wireless data and optics begin an important new growth trend. Broadcom (BRCM Quote - Cramer on BRCM - Stock Picks), National Semiconductor (NSM Quote - Cramer on NSM - Stock Picks), Applied Materials (AMAT Quote - Cramer on AMAT - Stock Picks) and Teradyne (TER Quote - Cramer on TER - Stock Picks) have major moves.

Now wouldn't this be a sight for sore eyes! A return to form for the chip stocks. Notable in its absence: Intel (INTC Quote - Cramer on INTC - Stock Picks). That tells you something about the way Wien sees the tech world unfolding. Also interesting: This list completely ignores two of the titans of yesteryear: Microsoft (MSFT Quote - Cramer on MSFT - Stock Picks) and Cisco (CSCO Quote - Cramer on CSCO - Stock Picks). One wonders if this is an omission of importance.

10. Causing some hostile comments from his brother Jeb, George W. Bush lifts the embargo on Cuba and allows unlimited travel and investment there. This unexpectedly spurs the South Florida economy, and the Bush brothers reconcile at an emotional Thanksgiving celebration. To finance infrastructure projects, Cuba issues bonds that can be redeemed in local currency or dollars. They become known as Castro convertibles.

Now this would be some surprise. After kind of edging toward surprises throughout the list, Wien lets go with a wild one. Perhaps we will see some kind of emotional Turkey Day festivities in the Bush household, but the idea of a complete lifting of the embargo? Not likely. If Wien gets this one right, I'll gladly fly to Havana and lift a glass in his honor. In fact, I'd lift several glasses and fly a gang of friends down with me. But I don't think I'll have to hustle to get those reservations anytime soon.

Another list, but always a good one. Amazing how the Fed move has changed the tenor of this list already, making much of it less surprising in nature.