This blog post originally appeared on RealMoney Silver on Dec. 27 at 10:28 a.m. EST.
"Never make predictions, especially about the future." -- Casey StengelThere are five lessons I have learned since my first surprise list for 2003:
- how wrong conventional wisdom can be;
- that uncertainty will persist;
- to expect the unexpected;
- that the occurrence of Black Swan events are growing in frequency; and
- with rapidly changing conditions, investors can't change the direction of the wind, but we can adjust our sails (and our portfolios) in an attempt to reach our destination of good investment returns.
Attempting to invest on the back of economic forecasts is an exercise in extreme folly, even in normal times. Economists are probably the one group who make astrologers look like professionals when it comes to telling the future. Even a cursory glance at Exhibit 4 reveals that economists are simply useless when it comes to forecasting. They have missed every recession in the last four decades! And it isn't just growth that economists can't forecast: it's also inflation, bond yields, and pretty much everything else. If we add greater uncertainty, as reflected by the distribution of the new normal, to the mix, then the difficulty of investing based upon economic forecasts is likely to be squared!For 2011, consensus estimates for economic growth, corporate profits, stock-price targets and interest rates are grouped in an extraordinarily tight range. I have chosen to use Goldman Sachs' forecasts as a proxy for the consensus. Here are Goldman Sachs' principal views of expected economic growth, corporate profits, inflation, interest rates and stock market performance:
- 2011 GDP up 3.4% (global GDP up 4.7%);
- 2011 S&P 500 operating profits of $94 a share;
- year-end S&P 500 price target at 1450 (a gain of about 15%) ;
- 2011 inflation of 0.5%; and
- the 2011 closing yield on the 10-year Treasury note at 3.75%.
"Those who cannot remember the past are condemned to repeat it." -- George SantayanaLooking at history, there was no better example of misplaced optimism than in the period leading up to the Great Decession of 2008-2009, providing a vivid reminder of the poor forecasting ability and investment risks associated with the crowd's baseline expectations and the value of a surprise list that deviates from that consensus.
In the famous simile of the cave, Plato compares men to prisoners in a cave who are bound and can look in only one direction. They have a fire behind them and see on a wall the shadows of themselves and of objects behind them. Since they see nothing but the shadows, they regard those shadows as real and are not aware of the objects. Finally one of the prisoners escapes and comes from the cave into the light of the sun. For the first time, he sees real things and realizes that he had been deceived hitherto by the shadows. For the first time, he knows the truth and thinks only with sorrow of his long life in the darkness. -- Werner Heisenberg, Physics and PhilosophyLast year's surprise list had relatively poor results. Only about 40% of my surprises were achieved in 2010, well under the success ratio in previous years. By means of background, about 50% of my 2009 surprises were realized, 60% in 2008, 50% in 2007, one-third in 2006 , one-fifth in 2005, 45% in 2004 and one-third came to pass in the first year of our surprises in 2003. While my surprise list for 2010 hit on some of the important themes that dominated the investment and economic landscape this year, I failed to expect the announcement of further quantitative easing and did not accurately gauge investors' animal spirits that followed the proclamation of QE2.
- Economy. Real GDP and corporate profit growth was, as I suggested, far better than expected during the first half of 2010, and my surprise that U.S. equities would weaken (and that P/E ratios would contract) despite that strength was accurate (in that stocks exhibited a negative return during that period).
- Housing and jobs. Despite the overall economic strength, both housing and employment failed to recover.
- Interest rates. My surprise that the yield on the 10-year U.S. note would fall under 3% by midyear and end 2010 at about 3% was prescient.
- SEC investigations. The broadening of the SEC's assault on insider trading was a featured story in 2010.
- The Oracle of Omaha. Though Warren Buffett is still at the helm, our surprise that he would announce a possible successor was accurate.
- Hedge funds. Brilliant and legendary hedge-hogger Stanley Druckenmiller announced that he was leaving the investment business -- in line with our surprise that a leading hedge-hogger would announce his retirement.
- The improving momentum of domestic growth at the end of 2010 continues into the first half of 2011 but proves ephemeral by the summer.
- That improving momentum turns out to be nothing more than a brief respite and "recession fatigue," as reality and a new normal sets in.
- Americans remain in a foul mood, as the jobs market fails to improve despite the recent downtick in claims.
- Over there, multiple country austerity programs move Europe back into recession by year-end 2011. (Share prices of many large multinational industrials falter in the year's second half.)
- China continues to tighten, but inflation remains persistent, economic growth disappoints (see surprise No. 15), and it's stock market weakens further.
- Political gridlock and inertia in tackling the deficit incite the bond vigilantes. The yield on the 10-year U.S. note rises above 4.50% by the spring (see surprise No. 2).
- Trust continues to be lost, as the uncertainty brought by changes in the administration (see surprise No. 7) and the emergence of a third political party (see surprise No. 8) adversely impacts consumer and corporate confidence.
- Housing fades under the pressure of higher mortgage rates and the supply of shadow inventory coming onto the market in an avalanche of foreclosures. (A housing czar is named to implement a Marshall Plan for housing.)
- An across-the-board spike in commodities pressures corporate profit margins and real disposable incomes (see surprise No. 3).
- Price controls are briefly considered (and then rejected) by the Obama administration as oil soars to over $125 a barrel.
"The first thing we do, let's kill all the lawyers." -- William Shakespeare, Henry VI, Part 2Increased hostilities between the Republicans and Democrats become a challenge to the market and to the economic recovery next year. As the 2012 election moves closer, President Obama reverses his seemingly newly minted centrist views, as newly appointed Vice President Hillary Clinton becomes the administration's pit bull against the Republican opposition.
"The day the Fed came into being in 1913 may have been the beginning of the end, but the powers it caused took a long time to become a serious issue and a concern for the average Americans." -- Ron Paul, "End of the Fed"On the other side of the pew, as chairman of the Subcommittee on Domestic Monetary Policy, Congressman Ron Paul's fervent criticism of monetary policy and the lack of transparency of the Fed leads to further friction between the parties.
"'Refudiate,' 'misunderestimate,' 'wee-wee'd up.' English is a living language. Shakespeare liked to coin new words, too. Got to celebrate it!'" -- Sarah PalinSarah Palin, who can see the 2012 presidential election from her home in Alaska, continues her barbs against the opposition party and holds a large lead to be her party's presidential candidate in early 2011, but continued verbal and nonverbal blunders and policy errors coupled with an announcement that she has separated from her husband cause Palin to announce that she will not run on the Republican ticket. Massachusetts' Mitt Romney, Wisconsin's Paul Ryan and South Dakota's John Thune emerge as the leading Republican presidential candidates by year-end 2011. The resulting bickering yields little progress on deficit reduction. Nor does the rancor allow for an advancement of much-needed and focused legislation geared toward reversing the continued weak jobs market. The yield on the 10-year U.S. note, despite a sputtering economic recovery visible by third quarter 2011, rises to over 4.25%, as the bond vigilantes take control of the markets. The rate rise serves to put a further dent in the U.S. housing market, which continues to be plagued by an avalanche of unsold home inventory into the market as the mortgage put-back issue is slowly resolved. During the second half of the year, housing stocks crater, and the financial sector's shares erase the (sector-leading) gains made in late 2010 and early 2011. 3. Rising commodities prices become the single greatest concern for U.S. stock market and economy. Scarcity of water boosts agricultural prices and causes a military confrontation between China and India. The continued effect of global warming, the resumption of swifter worldwide economic growth in 2011, normal population increases and an accelerated industrialization in emerging markets (and the associated water contamination and pollution that follows) contribute importantly to more droughts and the growing scarcity of water, forcing a continued and almost geometric rise in the price of agricultural commodities (which becomes one of the most important economic and stock market themes in 2011). Increased scarcity of water and higher agricultural commodity prices (corn, wheat, beans, etc.) not only have broad economic consequences, but they become a destabilizing factor and serve as the basis for a developing powder keg in the relations between China and India. China has about 23% of the world's population but only approximately 7% of the world's fresh water supply. Moreover, China's water resources are not distributed proportionately; the 550 million residents in the more industrialized northern area of the country are supported by only one-fifth of the fresh water and the 700 million in the southern region of China have the other 80% of the country's fresh water supply. The shared resources of water supply have been a focal point of conflict between China and India since the 1962 Indo-China War. My big surprise is that in early 2011, tension intensifies based on a decision by the Chinese government to materially expand the plans for the diversion of the 1,800-mile long Brahmaputra River, which hugs the Chinese border before dipping into India, from the south back up to the water-deprived northern China area in an expansion of the Zangmu Dam project, original construction plans of which were announced earlier this year. At first, trade sanctions are imposed by India against China. Later in the year, the impoverished northeastern India region is the setting for massive protests aimed at China; ultimately, groups of Indian rebels, fearful of reduced availability of fresh water and the likelihood of flooding, actually invade southern China in retaliation. 4. The market moves sideways during 2011. While the general consensus forecast is for a rise of about 10% to 15% for the S&P 500 in 2011, the index ends up exactly where it closes the year in 2010. A flat year is a fairly rare occurrence. Since 1900, there have been only six times when the averages recorded a year-over-year price change of less than 3% (plus or minus); 2011 will mark the seventh time.
Neither a borrower nor a lender be;With a return profile reminiscent of the sideways markets of 1953 (-0.80%), 1960 (-0.74%) and 1994 (+1.19%), the senior averages also exhibit one of the least volatile and narrowest price ranges ever. The S&P 500 never falls below 1150 and never rises above 1300, as the tension between the cyclical tailwind of monetary ease (and the cyclical economic recovery it brings) are offset by numerous nontraditional secular challenges (e.g., fiscal imbalances in the U.S. and Europe; a persistently high unemployment rate that fails to decline much, as structural domestic unemployment issues plague the jobs market), and the continued low level of business confidence (reinforced by increased animosity between the Republicans and Democrats) exacerbates an already weak jobs market and retards capital-spending plans. Despite the current unambiguous signs of an improving domestic economy, as the year progresses the growing expectation of consistently improving economic growth and a self-sustaining recovery is adversely influenced by continued blows to confidence from Washington, D.C., serving to contribute to a more uneven path of economic growth than the bulls envision. With traditional economic analysis again failing to accurately predict the path of economic growth (as it did in 2008-09), behavioral economic analysis, linking psychology to the business cycle, gains popularity. Yale's Dr. Robert Shiller and former Fed Chairman Dr. Alan Greenspan write books on behavioral economics that become the Nos. 1 and No. 2 books on The New York Times nonfiction bestseller list. The sideways market of 2011 will prove to be a good year for opportunistic traders but a poor one for the buy-and-hold crowd as neither the bulls nor the bears will be rejoicing next Christmas. 5. Food and restaurant companies are among the worst performers in the S&P 500. (This surprise is an extension of surprise No. 3.) Several well-known multinational food companies and a host of domestic restaurant chains face margin and earnings pressures as they are unable to pass the violent rise in agricultural costs on to the consumer. Profit guidance for 2011 is taken down by Kellogg ( K), Kraft ( KFT), General Mills ( GIS) and many other exposed food companies. Publicly traded restaurant chains such as Darden Restaurants ( DRI), McDonald's ( MCD), Yum! Brands ( YUM), Brinker International ( EAT) and Ruby Tuesday ( RT) all take a hit owing to the abrupt contraction in profit margins as product demand swoons in the face of higher prices. As a consequence, food companies and restaurant chains are among the worst performers in the S&P next year. 6. The shares of asset managers suffer. I expect a series of populist initiatives by the current administration beginning with a frontal assault on mutual fund 12b-1 fees. The asset managers -- Franklin Resources ( BEN), T. Rowe Price ( TROW) and Waddell & Reed ( WDR) -- are exposed, and I am short all three of them. 7. Vice President Joe Biden and Secretary of State Hillary Clinton switch jobs by midyear 2011, 18 months before the 2012 presidential election. It is generally recognized that President Obama has been seriously weakened politically, but the situation gets worse early next year. A sustained and high level of unemployment and a quiescent housing market fail to revive, forcing the administration to consider some radical changes in order to survive in the presidential election of 2012. (While such a switch is unconventional, this move can be accomplished as the 25th Amendment sets out that the majorities in both houses of Congress would have to confirm Vice President Clinton; Secretary of State Biden would only have to be confirmed by the Senate.) The other benefits to the switcheroo:
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry. -- William Shakespeare, Hamlet
- Hillary Clinton would have almost a year and a half of experience and credibility in the vice president's office.
- She would be well-prepared to campaign for a Democratic ticket.
- An Obama/Clinton ticket would be viewed by many as unbeatable. Clinton is a relentless campaigner, and she would be a far more effect drawer of votes than Biden. (Consider how many votes Obama and Clinton combined received in the 2008 presidential primary campaign.)
- Clinton will be seen as very capable of deflecting the women's vote from Sarah Palin in 2012.
- Clinton still likely harbors dreams of the White House. She would immediately become the overwhelming favorite to garner the Democratic Party's presidential nomination in 2016. She would be 69 years old at that time.
- On experience alone, Clinton would be considered far more qualified than most of the other Republicans now being considered (e.g., Bobby Jindal, Mitt Romney and Tim Pawlenty)
- Fears of former-president interference in the White House have dissipated. Bill Clinton has stayed out of the limelight and has been discreet with regard to his private life.
My view is simple and starts with the observation that gold is a lot like religion. No one can prove that God exists ... or that God doesn't exist. The believer can't convince the atheist, and the atheist can't convince the believer. It's incredibly simple: Either you believe in God or you don't. Well, that's exactly the way I think it is with gold. Either you're a believer or you're not.What we do know is that gold is valued in an auction market based on the price where buyers ("the believers") and sellers ("the atheists") meet. With an inability to gauge gold's intrinsic value, wide price swings remain possible. And wide price swings are what I expect in 2011. There are numerous catalysts that can contribute to a surprising weakness in the price of gold in the upcoming year. But most likely, a large drop in the price of gold might simply be the result in a swing in sentiment that can be induced by a number of factors (or maybe even sentiment that the emperor (and gold investors/traders) aren't wearing anything at all!):
- Investors might grow increasingly comfortable in a self-sustaining, inflation-free worldwide economic recovery.
- Interest rates could ratchet higher, providing competition for non-income producing assets (like gold).
- The world stock markets could surprise to the upside, reducing investors' interest in real assets (like gold).
- The U.S. government might (astonishingly) address the deficit.
- Macro funds, like those managed by John Paulson, have outsized weightings in gold or even have established dedicated gold hedge funds.
- On Okeechobee Boulevard in West Palm Beach, Fla., handheld placards that used to advertise condominiums and single-family homes for sale (during the housing bubble) have been replaced by handheld signs advertising "We Buy Gold." On this well-populated street, gold-exchange stores have replaced the omnipresent real estate and cell-phone stores of the last speculative cycle. ("We Buy Gold," "Sell Your Unwanted Gold," "Get Cash Now For Your Gold" are names of a few of the retail outlets).
- Gold is even being dispensed in an ATM machine in the Town Center Mall in Boca Raton, Fla. and at a hotel in Abu Dhabi.
- The company that dispenses the gold is PMX Communities, a Boca Raton-based concern listed on the Pink Sheets. According to a recent release, the ATM gold-dispensing machines now operate in 12 locations around the world.
- My spam emails normally consist of Viagra and "male enlargement" solicitations, but offers to buy gold have been on the rise over the last few months.
- Microsoft is hemorrhaging cash in its Internet operations (estimated $2.5 billion of losses in the last 12 months). Yahoo! will immediately contribute $1.25 billion-plus of cash flow. (Applying a normal multiple, six times to nine times creates $8.5 billion of value to Microsoft from Yahoo!'s current earnings before interest, taxes, depreciation and amortization).
- Yahoo! boasts net cash of $3.4 billion.
- Yahoo!'s public holdings total $9.5 billion of value (AliBaba.com and Yahoo! Japan).
- Yahoo!'s private holdings total $6 billion. Yahoo! owns 40% of private AliBaba through two assets:
- A call option on Chinese search via Microsoft joint venture. Based on the value of Baidu, if Yahoo! gets a 10% share of the $50 billion Chinese search market, the value is $5 billion -- the value to Yahoo! is about $1 billion for each 10% of search share (40% of 50%).
- 40% of AliPay. This is the elephant in the room. Current AliPay payments are about two thirds of PayPal, but the company is growing much faster than PayPal, and its market potential is far greater. PayPal is currently worth $18 billion -- making AliPay valued at $12 billion. Yahoo!'s 40% is worth $5 billion now but will easily be $10 billion in three years.
Insider trading charges expand. The SEC alleges, in a broad-ranging sting, the existence of an extensive exchange of information that goes well beyond Galleon's Silicon Valley executive connections. Several well-known ,long-only mutual funds are implicated in the sting, which reveals that they have consistently received privileged information from some of the largest public companies over the past decade.The next SEC target is directed at some of the world's largest tech companies, including one of the leading manufacturers of flash-memory cards, one of the largest contract manufacturers and a big producer of integrated circuits. A high-profile, very senior executive in one of these companies is implicated and is forced out of his position.
- New York Stock Exchange volume and price volatility dry up (see surprise No. 4 on the sideways market).
- Fox Business Network closes because of lack of interest.
- CNBC reduces its live broadcasting schedule and resorts to paid programming before 6 a.m. and after 8 p.m.
- Particularly hard-hit is Greenwich, Connecticut -- the home of many of the biggest hedge-hoggers who are alleged to have committed insider trading violations. The residential real estate market in Greenwich collapses.