This blog post originally appeared on RealMoney Silver on July 20 at 8:30 a.m. EDT.
"To predict the behavior of ordinary people in advance, you only have to assume that they will always try to escape a disagreeable situation with the smallest possible expenditure of intelligence." -- Friedrich Nietzsche
We are now more than halfway through 2009.
The last 12 months has been one of the most tumultuous and painful periods in history. Recently, that pain has been supplanted by pleasure.
What does the balance of 2009 hold? How do we profit? For some possible answers, it's time to grade and update our
For a little background, in late December in each of the past six years, I have taken a page from my friend and former Morgan Stanley strategist Byron Wien (now the chief investment strategist at Pequot Capital Management) and prepared a list of possible surprises for the coming year.
"I'm astounded by people who want to 'know' the universe when it's hard enough to find your way around Chinatown." -- Woody Allen
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, and to disprove Nietzsche, who said that we live the same life over and over again. After all, Wall Street research is still very much conventional, almost universally bullish and consisting of nonvariant "groupthink" despite the attempts of reform over the past several years. Mainstream and consensus expectations are just that, and, in most cases, they are deeply imbedded into today's stock prices. If I succeed in at least making you think about outlier events, then the exercise has been worthwhile.
As a perspective our surprise lists for both
were our most accurate ever. As successful as the 2007 surprise list was, our 2008 list proved to be even more accurate. As I previously wrote, 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). It wasn't the quantity of the correctly predicted surprises that made 2008'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.
But that was yesterday, and we now face the present with a more-than-usual amount of uncertainty.
"I don't want to make the wrong mistake." --Yogi Berra
Thus far 2009's list of surprises has fallen short of our successes over the past two years. That said, at this year's halftime intermission, here are my grades and updates for my surprises for 2009.
- 1. The Russian mafia and Russian oligarchs are found to be large investors with Madoff. During the next few weeks, a well-known CNBC
investigative reporter documents that the Russian oligarchs, certain members of the Russian mafia and several Colombian drug cartel families have invested and laundered more than $2 billion in Madoff's strategy through offshore master feeders and through several fund of funds. There are several unsuccessful attempts made on Madoff and/or his family's lives. With the large Russian investments in Madoff having gone sour and in light of the subsequent acts of violence against his family, U.S./Russian relations, which already were at a low point, are threatened. Madoff's lawyers disclose that he has cancer, and his trial is delayed indefinitely as he undergoes chemotherapy.Grade A: Early this year, Bank Medici's Sonja Kohn was found to have been a $3.5 billion feeder into Madoff funds.
The New York Timesreported that she was in hiding for fear of retribution by Russian oligarchs and members of the Russian mafia who invested with her. While there were no attempts on Madoff's life, and his health is intact, we (and his former investors) can still be hopeful.
2. Housing stabilizes sooner than expected. President Obama, under the aegis of Larry Summers, initiates a massive and unprecedented Marshall Plan to turn the housing market around. His plan includes several unconventional measures: Among other items is a $25,000 tax credit on all home purchases as well as a large tax credit and other subsidies to the financial intermediaries that provide the mortgage loans and commitments. This, combined with a lowering in mortgage rates (and a boom in refinancing), the bankruptcy/financial restructuring of three public homebuilders (which serves to lessen new home supply) and a flip-flop in the benefits of ownership vs. the merits of renting, trigger a second-quarter 2009 improvement in national housing activity, but the rebound is uneven. While the middle market rebounds, the high-end coastal housing markets remain moribund, impacted adversely by the Wall Street layoffs and the carnage in the hedge fund industry.Grade B+: There are solid signs of a stabilization in the country's housing markets as the price of homes relative to incomes and rentals has markedly improved. (Both
Ron Insana and
Jim Cramer are on board with my view.) I remain optimistic that housing has bottomed (in price and activity), and I expect a steady improvement over the balance of the year.
3. The nation's commercial real estate markets experience only a shallow pricing downturn in the first half of 2009. President Obama's broad-ranging housing legislation incorporates tax credits and other unconventional remedies directed toward nonresidential lending and borrowing. Banks become more active in office lending (as they do in residential real estate lending), and the commercial mortgage-backed securities market never experiences anything like the weakness exhibited in the 2007 to 2008 market. Office REIT shares, similar to housing-related equities, rebound dramatically, with several doubling in the new year's first six months.Grade F-: I was wrong on all counts as the non-residential real estate markets are weakening on all fronts, and so have the REIT shares been market laggards. I don't expect these negative trends to change in the months ahead.
4. The U.S. economy stabilizes sooner than expected. After a decidedly weak January-to-February period (and a negative first-quarter 2009 GDP reading, which is similar to fourth-quarter 2008's black hole), the massive and creative stimulus instituted by the newly elected President begins to work. Banks begin to lend more aggressively, and lower interest rates coupled with aggressive policy serve to contribute to an unexpected refinancing boom. By March, personal consumption expenditures begin to rebound slowly from an abysmal holiday and post-holiday season as energy prices remain subdued, and a shallow recovery occurs far sooner than many expect. Second-quarter corporate profits growth comfortably beats the downbeat and consensus forecasts as inflation remains tame, commodity prices are subdued, productivity rebounds and labor costs are well under control.Grade B: During the first quarter and thus far throughout the second quarter, American industry has positioned itself well for the downturn. While a majority of companies in the
S&P 500 has missed sales forecasts, over two-thirds have beaten EPS estimates. Under the weight of massive cost-cutting, however, personal consumption expenditures began to weaken in May, a trend that has continued to date. Going forward, a historically low inventory-to-sales ratio should result in a mini
production boom and a better GDP print, but, from my perch, a self-sustaining economy seems to be a less than 50/50 proposition.
5. The U.S. stock market rises by close to 20% in the year's first half. Housing-related stocks (title insurance, home remodeling, mortgage servicers and REITs) exhibit outsized and market-leading gains during the January-to-June interval. Heavily shorted retail and financial stocks also advance smartly. The year's first-half market rise of about 20% is surprisingly orderly throughout the six-month period, as volatility moves back down to pre-2008 levels, but rising domestic interest rates, still weak European economies and a halt to China's economic growth limit the stock market's progress in the back half of the year.Grade C+: The major indices are up slightly on the year, though the
Nasdaq is materially higher and close to my 20% upside surprise.
Let me frame my market outlook for the balance of 2009 and into 2010.
History might not repeat itself exactly -- it usually rhymes -- so it's important to give a hat tip and to recognize the importance (and rigor) of using series and charts that plot conditions that have led to previous recoveries. Since many of those relationships previously failed to predict the developing recession and then failed to map out the severity of that recession, however, it is equally important to distinguish that it's different this time for a host of reasons. Just as the conditions that led to the downcyle were different and lacked historical precedent, so, too, will the likelihood of the immediate economic period be materially different than prior post-recession eras.
The unusual era of profligate consumption and ready assumption of debt (at almost every level) was a pendulum swung too far (credit easy), and often, in response, the pendulum goes too far in the opposite direction (credit dear). The coming cycle is further exacerbated by a record downturn in household net worths caused by a brutal bear market in stocks and an unprecedented drop in home prices. Further complicating one's forecast is the aforementioned draconian cost cutting by American industry that has produced consistent EPS beats despite sales shortfalls. In other words, another man's bread (corporations) will not fill your (the consumer's) belly. The household net worth drop could be further adversely impacted by the specter of spiraling wage deflation and, in all likelihood, an elevated level of joblessness in the years ahead -- and, in defense, an elevated level of savings and lower personal consumption expenditures.
The single most important question we have to address -- the investment riddle of the sphinx, especially after the market rally -- is whether a self-sustaining recovery is in the cards. As someone who spends his days speaking to companies, it is very bad out there, and I don't see how, in light of the factors mentioned above along with an inevitable increase in interest rates and tax rates for both consumers and corporations around the corner, a "self sustaining," non-double-dipping recovery is much better than a 50/50 proposition.
As a consequence, while market volatility will provide trading opportunities I don't see much upside or value in the markets over the balance of the year. I still see a
and base-building period for one last move in the fall. After that, I want to get out of Dodge, which seems to be a variant surprise against the backdrop of a rising chorus of bullishness.
- 6. A second-quarter "growth scare" bursts the bubble in the government bond market. The yield on the 10-year U.S. Treasury note moves steadily higher from 2.10% at year-end to over 3.50% by early fall, putting a ceiling on the first-half recovery in the U.S. stock market, which is range-bound for the remainder of the year, settling up by approximately 20% for the 12-month period ending Dec. 31, 2009. Foreign central banks, faced with worsening domestic economies, begin to shy away from U.S. Treasury auctions and continue to diversify their reserve assets. By year-end, the U.S. dollar represents less than 60% of worldwide reserve assets, down from 2008's year-end at 62% and down from 70% only five years ago. China's 2008 economic growth proves to be greatly exaggerated as unemployment surprisingly rises in early 2009 and the rate of growth in China's real GDP moves towards zero by the second quarter. Unlike more developed countries, the absence of a social safety net turns China's fiscal economic policy inward and aggressively so. Importantly, China not only is no longer a natural buyer of U.S. Treasuries but it is forced to dip into it's piggy bank of foreign reserves, adding significant upside pressure to U.S. note and bond yields.7. Commodities markets remain subdued. Despite an improving domestic economy, a further erosion in the Western European and Chinese economies weighs on the world's commodities markets. Gold never reaches $1,000 an ounce and trades at $500 an ounce at some point during the year. (Gold-related shares are among 2009's worst stock market performers.) The price of crude oil briefly rallies early in the year after a step up in the violence in the Middle East but trades in a broad $25 to $65 range for all of 2009 as President Obama successfully introduces aggressive and meaningful legislation aimed at reducing our reliance on imported oil. The price of gasoline briefly breaches $1.00 a gallon sometime in the year. The U.S. dollar outperforms most of the world's currencies as the U.S. regains its place as an economic and political powerhouse.Grade B: While gold never dropped dramatically, most other commodities fell hard in the early part of the year. Crude doubled in price from the first-quarter lows. I don't expect much change in commodity prices ahead.
8. Capital spending disappoints further. Despite an improving economy, large-scale capital spending projects continue to be delayed in favor of maintenance spending. Technology shares continue to lag badly and Advanced Micro Devices (AMD) - Get Report files bankruptcy.Grade B: Capital spending remains muted and should continue to be so.
9. The hedge fund and fund of funds industries do not recover in 2009. The Madoff fraud, poor hedge fund performance and renewed controversy regarding private equity marks (particularly among a number of high-profile colleges like Harvard and Yale) prove to be a short-term death knell to the alternative investments industry. As well, the gating of redemption requests disaffects high net worth, pension plan, endowment and University investors to both traditional hedge funds and to private equity (which suffers from a series of questionable and subjective marking of private equity deal pricings at several leading funds). Three of the 10 largest hedge funds close their doors as numerous hedge funds reduce their fee structures in order to retain investors. Faced with an increasingly uncertain investor base, several big hedge funds merge with like-sized competitors in a quickening hedge fund industry consolidation. By year-end, the number of hedge funds is down by well over 50%.Grade A-: The contraction in hedge funds
continued apace in 2009, and several large hedge funds (such as Pequot) have announced their intention to close. Moreover, the
recent recommendations to force
SEC registration of funds whose assets exceed $30 million should serve to further reduce the number of funds.
10. Mutual fund redemptions from 2008 reverse into inflows in 2009. The mutual fund industry does not suffer the same fate as the hedge fund industry. In fact, a renaissance of interest in mutual funds (especially of a passive/indexed kind) develops. Fidelity is the largest employer of the graduating classes (May 2009) at the Wharton and Harvard Business Schools; it goes public in late 2009 in the year's largest IPO. Shares of T. Rowe Price (TROW) - Get Report and AllianceBernstein (AB) - Get Report enjoy sharp price gains in the new year. Bill Miller retires from active fund management at Legg Mason (LM) - Get Report.Grade B+: Mutual fund inflows have steadily increased since March, but the trend toward discontinuance of 401(k) matches by leading companies augurs poorly for a continuation of inflows, particularly if equities pause or drop back down. Bill Miller is still at the helm of Legg Mason's mutual funds complex.
11. State and municipal imbalances and deficits mushroom. The municipal bond market seizes up in the face of poor fiscal management, revenue shortfalls and rising budgets at state and local levels. Municipal bond yields spike higher. A new Municipal TARP totaling $2 trillion is introduced in the year's second half.Grade A: The municipal bond market was in disarray in 2009, and the imbalance between receipts and expenditures should weigh on the municipal bond market for years.
12. The automakers and the UAW come to an agreement over wages. Under the pressure of late first-quarter bankruptcies, the UAW agrees to bring compensation in line with non-U.S. competitors and exchanges a reduction in retiree health care benefits for equity in the major automobile manufacturers.Grade B: While compromises were met, it didn't stave off a
General Motors bankruptcy.
13. The new administration replaces SEC Commissioner Cox. SEC Commissioner-designate Mary Schapiro becomes mired in the Madoff investigation. Upon his inauguration, President Obama immediately replaces SEC Commissioner Christopher Cox with Yale professor Dr. Jeffrey Sonnenfeld. The new SEC commissioner recommends that the uptick rule be reinstated and undertakes a yearlong investigation/analysis into the impact of Ultra Bear ETFs on the market. Later in the year, the administration recommends that the SEC be abolished and folded into the Treasury Department. Dr. Sonnenfeld returns to Yale University.Grade F: I was way off on this one, even though Mary Schapiro faces
continued criticism of policy.
14. Large merger of equals deals multiply. Economies of scale and mergers of equals become the M&A mantras in 2009, and niche investment banking boutiques such as Evercore (EVR) - Get Report, Lazard (LAZ) - Get Report and Greenhill (GHL) - Get Report flourish. Goldman Sachs (GS) - Get Report and Citigroup (C) - Get Report announce a merger of equals, but Goldman maintains management control of the combined entity. Morgan Stanley (MS) - Get Report acquires Blackstone (BX) - Get Report. Disney (DIS) - Get Report purchases Carnival (CCL) - Get Report. Microsoft (MSFT) - Get Report acquires Yahoo! (YHOO) at $5 a share.Grade F: Way off on this one too!
15. Focus shifts for several media darlings. Though continuing on CNBC
, Jim "El Capitan" Cramer announces his own reality show that will air on NBC
in the fall. At the time his reality show premieres, he also writes a new book, Stay Mad for Life: How to Prosper From a Buy/Hold Investment Strategy
. Dr. Nouriel Roubini continues to talk depression, but the price of his speaking engagements are cut in half. He writes a new book, The New Depression: How Leverage's Long Tail Will Result in Bread Lines
. "Kudlow & Company's" Larry Kudlow proclaims that it's time to harvest the "mustard seeds" of growth and, in an admission of the Democrats' growing economic successes, officially leaves the ranks of the Republican party and returns to his Democratic roots. Yale's Dr. Robert Shiller adopts a variant and positive view on housing and the economy, joining the bullish ranks, and writes a new book, The New Financial Order: Economic Opportunity in the 21st Century
.Grade C+: Some right, some wrong. Jimmy continues to be concentrating on the successful "Mad Money" train, and,
not surprisingly, Sir Larry Kudlow is still a true blue Republican. Yale's Dr. Shiller sees green seeds in housing.
Nouriel Roubini and Meredith Whitney seem to be wavering in their pessimism.
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 uses DoS against media and e-commerce sites. Second, a major data center will fail and will be far worse than the 1988 Cornell student incident 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 (such as liquidating and sweeping online brokerage accounts and shorting stocks, then employing a denial-of-service attack against the company). Fourth, Storm Trojan reappears. (Same as last year.)Grade A: I caught an important theme in the issue of
cyberattacks, which appears to be a growing threat in this decade.
17. A handful of sports franchises file bankruptcy. Three Major League Baseball teams fail in the middle of the season and seek government bailouts in order to complete the season. The Wilpon family, victimized by Madoff, sells the New York Mets to SAC's Steve Cohen. The New York Yankees are undefeated in the 2009 season, and Madonna and A-Rod have a child together (out of wedlock).Grade A: Several major league sports franchises have filed bankruptcy or are hurting badly. Ticket price concessions will continue,
even at Yankee Stadium, but a double-dipping economy in 2010 could hasten substantially lower attendance and additional bankruptcy filings.
18. TheFox Business Network closes. Racked by large losses, Rupert Murdoch abandons the Fox Business Network
rehires several prior employees and expands its programming into complete weekend coverage. Two popular CNBC
commentators "go mainstream" and become regulars on NBC
news programs.Grade C-: Nothing yet on
Fox Business Network, but its viewership is embarrassingly low. I suspect Murdoch holds on, even as losses mount, but his patience must be tested now.
19. Old, leveraged media implode. The worlds of leverage and old media collide in a massive flameout of previous leveraged deals. Univision and Clear Channel go bankrupt. The New York Times (NYT) - Get Report teeters financially.Grade A: Old media is a landmine of failing companies. Things don't get better in late 2009.
20. The Middle East's infrastructure build-out is abruptly halted owing to "market conditions." Lower oil prices, weakening European economies and a broad overexpansion wreak havoc with the Middle East's markets and economies.Grade B+: Reflecting an overbuild, several high-profile infrastructure projects have been canceled or suspended in the Middle East.
Grade B+: Treasury yields ripped higher during the first half of 2009, approaching 4% recently, but China's growth continues to forge ahead, and its central bank appears to be a steady (but somewhat less enthusiastic) buyer of treasuries. I expect the yield on bonds to be more or less unchanged from current levels over the course of 2009.
Doug Kass writes daily for
, a premium bundle service from TheStreet.com. For a free trial to
and exclusive access to Mr. Kass's daily trading diary, please click here.
At the time of publication, Kass and/or his funds were long DIS and MSFT but short TROW, 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 Long/Short LP.