A Prelude to My Fifteen Expected Surprises In 2018
"DIVERSITY AND INDEPENDENCE ARE IMPORTANT BECAUSE THE BEST COLLECTIVE DECISIONS ARE THE PRODUCT OF DISAGREEMENT AND CONTEST, NOT CONSENSUS OR COMPROMISE."
--JAMES SUROWIECKI, "THE WISDOM OF CROWDS"
"NEVER MAKE PREDICTIONS, ESPECIALLY ABOUT THE FUTURE."
It's almost that time of the year again!
I plan to unveil my 15 Surprises for 2018 in a few days.
This is the 16th year that I have created my annual list of surprises on Real Money Pro.
Over time "Group Stink" has been increasingly embraced by the consensus, where extrapolation is the core foundation of forecasts. There is literally nothing value-added in the consensus' output, which is based on an extension of recent earnings trends coupled with some valuation (price-to- earnings multiple) expansion. This is best manifest when looking at the closely held views of Wall Street strategists in their annual stock market forecasts, which are almost universally higher and which predictably will show 7% to 8% year-over-year gains in equity market. (This is the case already for strategists' market forecasts for 2018.)
This is the essence of why I deliver my Surprise lists.
In my investment career I've never walked the same path that others have found comfortable and I'm not going to start now. You see, I find beauty in a variant view. It's satisfying intellectually, analytically and financially (at least when you're correct). As I wrote in "Embracing the Contrary," there is something special about adopting a non-consensus view and watching it become reality despite protests from many corners. This statement forms the basis for my annual Surprise List.
The purpose of my annual Surprise List is to get readers to think more deeply about a variety of issues and to consider the contrary.
By means of background and for those new to Real Money Pro, 15 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 is always fun to compare our surprises). Here was Byron's Surprise List for 2017.
It takes me about three weeks of thinking and writing to compile and construct my annual Surprise List column. I typically start with about 40 surprises, which are accumulated during the months leading up to my column. I cull the list to come up with my final 15 Surprises and often include, as I did last year, some 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; every year I ask a different set of people for their advice and ideas. I always have associated the moment of writing the final draft (in the weekend before publication) of my annual Surprise List with a moment of lift and joy and the thought of unexpected investment rewards, hopefully, 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 crowd often outsmarts 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.
"You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right."
--Legendary value investor Ben Graham (who in the short term recognized the market was a voting machine, not a weighing machine)
Confidence, perhaps more today than ever, is the most abundant quality on Wall Street as stocks climb higher over time. Good markets mean happy investors and even happier investment professionals.
The factors stated above help to explain the crowded and benign consensus with which every year begins, whether measured 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 three years ago, which differed dramatically from the consensus expectations. And consider my outlier view in late 2014 that the drop in oil prices would fail to help the economy and that OPEC would come close to dissolution as oil prices would plummet. An investor could have done quite well by following that message of 24 months ago by avoiding energy stocks in 2015.
To a large degree the business media perpetuates group-think and coddles investors, often into a false sense of security; I call this "group stink." 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 a criterion for appearances was accuracy, there would have been few available guests in 2009-10 qualified to appear on CNBC, Bloomberg and Fox Business News.
Indeed, after eight years of market prosperity, the few investment bears remaining are often 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 Montier, in an excellent essay published several years ago, made note of the consistent weakness embodied in consensus forecasts:
"Economists 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."
"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)
There are five core lessons I have learned over the course of my investing career that form the foundation of my annual surprise lists:
* How wrong conventional wisdom consistently can be.
* That uncertainty will persist.
* To expect the unexpected.
* That the occurrence of Black Swan events is growing in frequency.
* 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.
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 reforms spurred by former New York Attorney General Eliot Spitzer. It 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, Citicorp, 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 Gov. 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.
But enough of that rant.
Before I outline my new Surprises in a few days, I always issue a report card of my previous year's Surprises. This year is no different.
As it turns out, 2017 was my worst year ever, with a record low four Surprises out of 15 on target; that's in marked contrast to 2016 (60% correct), which was a very good year relative to my historic percentages, though 2015 also was a very good year.
Three years ago, my 15 Surprises for 2014 had a success rate of about 40%, which is about in line with what I have achieved over time. .
Many readers of this annual column assume that my Surprise List will have a bearish bent -- and to be sure, that was the case for 2016 and is the case for the coming year. But I have not always expressed a negative outlook in my Surprise List. My 2012 Surprise List had an out-of-consensus positive tone to it, though 2013's list was noticeably downbeat relative to the general expectations. As I previously noted, in 2014 my success rate was at about 40%, which included five also-ran predictions.
This contrasted with my 15 surprises for 2013, which had the poorest success rate since 2005's list (20%). By comparison, my 2012 Surprise List achieved about a 50% hit ratio, similar to my experience in 2011. About 40% of my 2010 surprises were achieved, while I had a 50% success rate in 2009, 60% in 2008, 50% in 2007, 33% in 2006, 20% in 2005, 45% in 2004 and 33% in 2003, the first year of my surprises.
Below is a report card of my 15 surprises for 2017. I give myself a "D":
Surprise No. 1: The New Year Starts Out On a Sour Note and Sets a Negative Market Tone for the Year as Sears Holdings Declares Chapter 11 Bankruptcy in Early January 2017-- WRONG
Surprise No. 2: The Trump Election Victory Establishes an Important Precedent and Is Followed by a Broad and General Movement in Which Prominent Businessmen, Celebrities, Sports Figures and Others Without Prior Political or Military Experience Consider Political Office. -- RIGHT
Surprise No. 3: Shortly After the Inauguration, Donald Trump's Security Advisers Convince Him to Cease Tweeting and to Close His Twitter Account (@realDonaldTrump). -- WRONG
Surprise No. 4: "The Unartful Deal" -- President Trump's Popularity Quickly Fades as "The Dude (Doesn't ) Abide." -- RIGHT
Surprise No. 5: Trump Grows Restless After Some Failed Initiatives and Loss of Support. He Begins to Lose Interest in His Job After He Finds Out How Hard It Is to Get Anything Done-- WRONG
Surprise No. 6: Early in 2017, Higher Wages, Rising Interest Rates and Higher Input Prices Squeeze Profit Margins-- WRONG
Surprise No. 7: The Stock Market Makes Its High in the First Two Weeks of January and Goes Downhill the Rest of the Year, Ending Down 15% for 2017. -- VERY WRONG
Surprise No. 8: There Are No Fed Rate Increases in 2017 -- VERY WRONG
Surprise No. 9: Yellen Resigns Under Pressure From the New Administration. -- WRONG (HOWEVER, SHE WAS RECENTLY REPLACED BY THE PRESIDENT)
Surprise No. 10: "Quantitative Easing Endless" Becomes Reality and the Fed Sets the 10-Year Yield at 1.5% to 1.75%. -- VERY WRONG
Surprise No. 11: "Brexit" Turns into "Bremain."-- WRONG
Surprise No. 12: In a Weakening Stock Market, the Burgeoning ETF Business Suffers Instability After a Series of Stock Market Mini "Flash Crashes." -- VERY WRONG
Surprise No. 13: Drill, Baby, Drill.-- VERY RIGHT
Surprise No. 14: Apple Is Still Crapple -- VERY WRONG
Surprise No. 15: Goodbye, "Peak Autos" -- Car Industry Sales Don't Peak and Have Another Ramp Higher - RIGHT