It's that time of year when people start thinking about New Year's resolutions and investment planning for the future. It's also the time of year when analysts feel more or less compelled to offer up forecasts. My friend Doug Kass turns the forecasting process on its head by offering 15 potential surprises for 2015 (plus 10 also-rans). But he does so with a healthy measure of humility, starting out with a quote from our mutual friend James Montier (now at GMO):
(E)conomists can't forecast for toffee … 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, unemployment, stock market price targets 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!
Lessons Learned Over the Years
“I'm astounded by people who want to ‘know' the universe when it's hard enough to find your way around Chinatown.” – Woody Allen
There are five core lessons I have learned over the course of my investing career that form the foundation of my annual surprise lists:
Quoting from a very eclectic group of names, Doug does indeed give us a few surprises to think about, and I pass his thoughts on to you as this week's Outside the Box. (Doug publishes his regular writings in RealMoneyPro on theStreet.com.)
As a bonus, and as a thoughtful way to begin the new year, we have a letter that my good friend and co-author of my last two books Jonathan Tepper wrote to his nephews. He began penning it on a very turbulent plane ride that he was uncertain of surviving. It made him think hard about what was really important that he would want to pass on to his nephews. As the song goes, I found a few aces that I can keep in this hand. I think you will too.
His letter made me think about what I want to be passing on to my grandchildren, including the newest one, Henry Junior, who showed up less than 24 hours ago. They are going to grow up in a very different world than the one I grew up in, and I mostly think that's a good thing. But the values that I hope can be passed on don't change. Good character never goes out of fashion.
My associate Worth Wray came down with a very nasty bug this past weekend, so he missed his deadline for delivering his 2015 forecast to you. We're giving him a few more days and will run it this weekend – which also of course gives me a little more time to mull over my own forecast. Taking to heart James Montier's quote above, I'm going to forgo the usual 12-month forecast and look farther out, thinking about what major events are likely to come our way over the next five years. I actually think that approach will be for more useful for our longer-term planning.
Thanks for being with me and the rest of the team at Mauldin Economics this past year; and from all of us, but especially from me, we wish you the best and most prosperous of new years.
You're staring hard at crystal balls analyst,
John Mauldin, Editor
Outside the Box [email protected]
15 Surprises for 2015
Doug Kass, Seabreeze Partners
Dec. 29, 2014 | 8:12 AM EST
Article mentions: C, SBUX, TSLA, TWTR, GM, GLD, JNK, SPY, QQQ, AAPL, BAC, GOOGL, FB, CSCO
It's that time of year again.
“Never make predictions, especially about the future.” – Casey Stengel
By means of background and for those new to Real Money Pro, 12 years ago I set out and prepared a list of possible surprises for the coming year, taking a page out of the estimable Byron Wien's playbook. Wien originally delivered his list while chief investment strategist at Morgan Stanley, then Pequot Capital Management and now at Blackstone. (Byron Wien's list will be out in early January and it will be fun to compare our surprises.)
It takes me about two to three weeks of thinking and writing to compile and construct my annual surprise list column. I typically start with about 30-40 surprises, which are accumulated during the months leading up to my column. In the days leading up to this publication I cull the list to come up with my final 15 surprises. (Last year I included five also-ran surprises.)
I often speak to and get input from some of the wise men and women that I know in the investment and media businesses. I have always associated the moment of writing the final draft (in the weekend before publication) of my annual surprise list with a moment of lift, of joy and hopefully with the thought of unexpected investment rewards in the New Year.
This year is no different.
I set out as a primary objective for my surprise list to deliver a critical and variant view relative to consensus that can provide alpha or excess returns.
The publication of my annual surprise list is in recognition that economic and stock market histories have proven that (more often than generally thought) consensus expectations of critical economic and market variables may be off base.
History demonstrates that inflection points are relatively rare and that the crowds often outsmart the remnants. In recognition, investors, strategists, economists and money managers tend to operate and think in crowds. They are far more comfortable being a part of the herd rather than expressing – in their views and portfolio structure – a variant or extreme vision.
Confidence is the most abundant quality on Wall Street as, over time, stocks climb higher. Good markets mean happy investors and even happier investment professionals.
The factors stated above help to explain the crowded and benign consensus that every year begins with, whether measured either by economic, market or interest-rate forecasts.
But an outlier's studied view can be profitable and add alpha. Consider the course of interest rates and commodities in 2014, which differed dramatically from the consensus expectations.
To a large degree the business media perpetuates group-think. Consider the preponderance of bullish talk in the financial press. All too often the opinions of guests who failed to see the crippling 2007-09 drama are forgotten and some of the same (and previously wrong-footed) talking heads are paraded as seers in the media after continued market gains in recent years.
Memories are short (especially of a media kind). Nevertheless, if the criteria for appearances was accuracy there would have been few available guests in 2009-2010 qualified to appear on CNBC, Bloomberg and Fox News Business.
Indeed, the few bears remaining are now ridiculed openly by the business media in their limited appearances, reminding me of Mickey Mantle's quote, “You don't know how easy this game is until you enter the broadcasting booth.”
Abba Eban, the Israeli foreign minister in the late 1960s and early 1970s once said that the consensus is what many people say in chorus, but do not believe as individuals.
GMO's James Moniter, in an excellent essay published several years ago, made note of the consistent weakness embodied in consensus forecasts.
As he put it:
“(E)conomists can't forecast for toffee … 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, unemployment, stock market price targets 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!”
Lessons Learned Over the Years
“I'm astounded by people who want to ‘know' the universe when it's hard enough to find your way around Chinatown.” – Woody Allen
There are five core lessons I have learned over the course of my investing career that form the foundation of my annual surprise lists:
“Let's face it: Bottom-up consensus earnings forecasts have a miserable track record. The traditional bias is well-known. And even when analysts, as a group, rein in their enthusiasm, they are typically the last ones to anticipate swings in margins.” – UBS (top 10 surprises for 2012)
Let's get back to what I mean to accomplish in creating my annual surprise list.
It is important to note that my surprises are not intended to be predictions, but rather events that have a reasonable chance of occurring despite being at odds with the consensus. I call these possible-improbable events. In sports, betting my surprises would be called an overlay, a term commonly used when the odds on a proposition are in favor of the bettor rather than the house.
The real purpose of this endeavor is a practical one – that is, to consider positioning a portion of my portfolio in accordance with outlier events, with the potential for large payoffs on small wagers/investments.
Since the mid-1990s, Wall Street research has deteriorated in quantity and quality (due to competition for human capital at hedge funds, brokerage industry consolidation and former New York Attorney General Eliot Spitzer-initiated reforms) and remains, more than ever, maintenance-oriented, conventional and group-think (or group-stink, as I prefer to call it). Mainstream and consensus expectations are just that and, in most cases, they are deeply embedded into today's stock prices.
It has been said that if life were predictable, it would cease to be life, so if I succeed in making you think (and possibly position) for outlier events, then my endeavor has been worthwhile.
Nothing is more obstinate than a fashionable consensus and my annual exercise recognizes that, over the course of time, conventional wisdom is often wrong.
As a society (and as investors), we are consistently bamboozled by appearance and consensus.
Too often, we are played as suckers, as we just accept the trend, momentum and/or the superficial as certain truth without a shred of criticism. Just look at those who bought into the success of Enron, Saddam Hussein's weapons of mass destruction, the heroic home-run production of steroid-laced Major League Baseball players Barry Bonds and Mark McGwire, the financial supermarket concept at what was once the largest money center bank, Citigroup (C), the uninterrupted profit growth at Fannie Mae and Freddie Mac, housing's new paradigm (in the mid-2000s) of non-cyclical growth and ever-rising home prices, the uncompromising principles of former New York Governor Eliot Spitzer, the morality of other politicians (e.g., John Edwards, John Ensign and Larry Craig), the consistency of Bernie Madoff's investment returns (and those of other hucksters) and the clean-cut image of Tiger Woods.
My Surprises for 2014
These generally proved in line with my historic percentages.
“How'm I doin'?” – Ed Koch, former New York City mayor
While over recent years many of my surprise lists have been eerily prescient (e.g. my 2011 surprise that the S&P 500 would end exactly flat was exactly correct), my 15 Surprises for 2014 had a success rate of about 40%, about in line with what I have achieved over the last 11 years.
As we entered 2014, most strategists expressed a constructive economic view of a self-sustaining domestic recovery, held to an upbeat (though not wide-eyed) corporate profits picture and generally shared the view that the S&P 500 would rise by between 8-10%.
Those strategists proved to be correct on profit growth (but only because of several non-operating factors and financial engineering), were too optimistic regarding domestic and global economic growth and recognized (unlike myself) that excessive liquidity provided by the world's central bankers would continue to lift valuations and promote attractive market gains in 2015. Not one major strategist foresaw the emerging deflationary conditions, the precipitous drop in the price of oil and the broad decline in domestic and non-U.S. interest rates.
Many readers of this annual column assume that my surprise list will have a bearish bent (to be sure that is the case for 2015). But I have not always expressed a negative outlook in my surprise list. Two years ago my 2012 surprise list had an out-of-consensus positive tone to it, but 2013's list was noticeably downbeat relative to the general expectations. I specifically called for a stock market top in early 2013, which couldn't have been further from last year's reality, as January proved to be the market's nadir. The S&P closed at its high on the last day of the year and exhibited its largest yearly advance since 1997. (I steadily increased my fair market value calculation throughout the year and, at last count, I concluded that the S&P 500's fair market value was about 1645.)
