"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
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
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
, 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."
It will be hard to do it again and beat last year's surprises, but without further ado, here is my Surprise List 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.
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.
2. Under pressure from slowing consumer spending, disappointing capital spending and higher commodities, corporate profits drop 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.
3. The S&P 500 Index falls by 5%-10% in 2008, and 2007's laggards and leaders continue to be the same laggards and leaders in the coming year.
4. With a continuation of the credit and liquidity crises and an increased recognition that financial retrenchment will take years (not months), volatility pushes even higher. Daily moves of 1%-2% become more commonplace, serving to further alienate the individual investor.
5. The Federal Reserve embarks upon a series of moves to ease monetary policy in 2008. Nearly every meeting is accompanied by a 25-basis-point decrease in the federal funds rate even despite continued inflationary pressures.
Nevertheless the economy fails to revive as the Fed
pushes on a string
6. Growth in the Western European economies deteriorates throughout the year, and the markets in England and France drop at twice the rate of the U.S. market.
7. The Chinese juggernaut continues apace and, despite continued protestations of a market bubble, the Chinese market doubles again in 2008.
8. The Japanese market puts on a surprising resurgence as the world's investors respond to compressed valuations (vis-à-vis peer regions), reasonable multiples (absolutely and against Japanese bond yields), accelerated M&A activity, share buybacks and relative strong corporate profit growth.
9. The administration's proposal to revive the housing market falls on its face (as the housing bust accelerates), and President Bush enlists a well-placed Democrat and former cabinet member to become the U.S. housing czar, who has the primary charge to propose and administer a massive Marshall Plan for housing.
Several high-profile housing-related bankruptcies occur in 2008, including
10. Financial stocks fail to recover. No financial company is immune to the eroding market conditions, the spike in market volatility, the uneven direction in commodities and currency prices. Even the leader of the pack,
, makes several bad bets in the derivative, currency and commodity markets, and its shares begin to underperform its peers as profit forecasts move lower.
halves its dividend, and the shares briefly trade in the mid-$20s. Asset sales and writedowns leave the bank crippled, and in late 2008 (after another capital infusion by Abu Dhabi), Citi is merged with
Bank of America
. Its new name is its old name: CitiBank!
is acquired by
in a take-under (well below today's price) -- as
loses nearly $350 million on his near-10% position in the brokerage firm.
Mutual fund outflows and uncertainty regarding the integrity of money market funds result in the asset-management stocks being among the worst-performing sectors in 2008. With private-equity deals at a standstill,
shares trade down close to $10 a share. Late in the year, CEO Stephen Schwarzman and his management group take the company private.
11. With the economy weakening and corporate profits tumbling, investors pay up -- real up -- for growth. The three horsemen --
Research In Motion
-- move into bubble status, and short interest triples as the naysayers increase their bets. Their shares double in 2008 even as most equities decline.
Technology disappoints as it becomes clear by the beginning of the second quarter that "double ordering" inflated recent revenue gains as the weakening consumers' appetite for electronics founders. Rapidly growing biotech names are embraced as their P/Es grow high into the sky and they become the New Big Thing, and market leaders. Housing-centric equities continue to deflate and mop up the rear.
12. Although private-equity M&A activity remains moribund, 2008 is highlighted by numerous mergers of equals as a weak U.S. economy necessitates the need for a strategy that produces synergies and cuts costs.
merge. So do
13. A weakening economy will also hasten a number of divestitures.
will sell NBC Universal to
, which will not sell or spin off AOL.
14. Reversing its recent strength, the U.S. dollar's value falls by over 10% in 2008 (and gold rises to over $1,000 an ounce). Despite the weak domestic economy, foreign reserve diversification efforts and the demand for higher interest rates cause the yield on the 10-year U.S. note to move higher throughout the year.
15. The price of crude oil, insensitive to a weakening world economy, eclipses $135 per barrel after an "exogenous" event of terrorism, supply disruptions or political upheaval. The $100 level becomes the new $70! Surprisingly, energy stocks react in a muted fashion to the rip in price as, by midyear, the Democratic Party's populist view of a windfall tax on energy companies gains increased acceptance.
16. The Internet becomes the tactical nuke of the digital age. The Web is invaded on many levels as governments, consumers and investors freak out. First, an act of cyberterrorism occurs that compromises the security of a major government (similar to the attacks this year emanating from the Chinese military aimed at the German Chancellery) or
against media and e-commerce sites.
Second, a major data center will fail and will be far worse than the
that infected about 5% of the Unix boxes on the early Internet.
Third, cybercrime explodes exponentially in 2008. Financial markets will be exposed to hackers using elaborate fraud schemes (like liquidating and sweeping online brokerage accounts and shorting stocks, then employing a denial of service attack against the company). Fourth,
17. The hedge fund community (especially of a quant kind) is disintermediated in 2008. Outflows accelerate, abetting an already conspicuous trend of rising volatility in a market that behaves more like a commodity than ever.
18. There are several major Enron-like accounting scandals in 2008, causing investor confidence to plummet. These will come in some large financial and industrial (rollup) companies in Europe and the U.S.
19. Democrats Clinton/Kerrey and Republicans McCain/
represent their parties in the presidential/vice presidential contest in November. Ron Paul becomes the Libertarian candidate. In a remarkably close election (reminiscent of the Bush/Gore battle of 2000), the Democrats grab the White House.
20. The politics of trade become more fractious (even in the Republican Party) as angst about globalization escalates in the U.S., reflecting inequalities and a cyclical contraction in our domestic economy.
. And the new Big Things (and the source of liquidity for the capital markets) -- Sovereign Wealth Funds -- become targets of American politicians (and suppress U.S. equities further).
At time of publication, Kass and/or his funds were short C, JPM, RDN, CFC, BAC, AMZN, and long AMZN puts and calls, although holdings can change at any time.
Doug Kass is founder and president of Seabreeze Partners Management, Inc., and the general partner and investment manager of Seabreeze Partners Short LP and Seabreeze Partners Short Offshore Fund, Ltd.