White House Politics:
(When asked what he wanted to give thanks for during a press gaggle Thanksgiving Thursday, Trump responded), “for having a great family and for having made a tremendous difference in this country. I’ve made a tremendous difference in the country. This country is so much stronger now than it was when I took office that you wouldn’t believe it… And I mean, you see, but so much stronger people can’t even believe it. When I see foreign leaders they say we cannot believe the difference in strength between the United States now and the United States two years ago.” – President Trump (Comments on Thanksgiving)
“You only think I guessed wrong! … You fool! You fell victim to one of the classic blunders – the most famous of which is “never get involved in a land war in Asia” – but only slightly less well-known is this: Never go in against a Sicilian when death is on the line!” – Vizzini,The Princess Bride
“The missing step in the standard Keynesian theory (is) the explicit consideration of capitalist finance within a cyclical and speculative context… finance sets the pace for the economy. As recovery approaches full employment… soothsayers will proclaim that the business cycle has been banished (and) debts can be taken on. But in truth neither the boom nor the debt deflation… and certainly not a recovery can go on forever. Each state nurtures forces that lead to its own destruction.” – Hyman Minsky
“Every new beginning comes from some other beginning’s end.” –Seneca the Elder
Contrary to the expectations of many (including myself), the uncertainties following the surprising Trump presidential election victory, which produced a number of possible outcomes (some of them adverse), was enthusiastically embraced by investors in 2017 and in the first month of this year. A market on steroids was not a conclusion or forecast by any mainstream Wall Street forecaster that year. There was no sell side strategist who expected equities would rise anywhere near the 20%+ gains in the major indices recorded in 2017, nor do I know any who predicted that the S&P Index would make more than 70 individual highs a year ago.
As I expected, that enthusiasm continued in and through most of the month of January, 2018. But, after a year of historically low volatility and ever-rising stock prices, the bullish consensus became troubled as the complexion of the market changed throughout most of 2018 .
As I noted in last year’s commentary, I thought that the biggest surprise in 2018 would be that extrapolation of the market uptrend didn’t work after many years of working, and that we will witness the emergence of multiple non-consensus developments, including:
- A dramatic drop in the price of bitcoin (to under $2,000)
- A devastating decline in many bitcoin collateral plays
- A much higher oil price
- A slowing (not expanding) rate of economic domestic growth as the tax bill “trickles up,” not down
- A mean reversion higher in volatility
- The bursting of the global short volatility bubble which serves up a 20% drop in equities (aided by both weaker earnings results and lower valuations).
- And, of course, I anticipated that there would be an abundance of surprises in the fertile political arena with the incalculable Orange Swan at the helm in Washington, D.C., and in his role as the “Supreme Tweeter.”
“Expect the unexpected and, whenever possible, be the unexpected.” – Kurt Vonnegut, Breakfast of Champions
As we enter 2019, the scent of “Group Stink” is still thick despite a heady list of multiplying uncertainties. Nevertheless, while the Bull Market in Complacency has been pierced in October, 2018, most market forecasts remain optimistic.
Warren Buffett once observed that a bull market “is like sex. It feels best just before it ends.’” While some of us in the ursine crowd debate whether the investment orgasm has already passed, in the extreme it finally may be Minsky’s Moment and year after nine years of recovery and prosperity following The Great Recession.
This year I have decided to publish my “Surprise List” a bit earlier than usual.
As you all know, my Surprises are what I term to be Probable Improbables – events that have a greater possibility of occurring than are seen by the consensus. I try to make you think apart from that diabolically dangerous “Group Stink” and, particularly as it relates to politics (but with other subjects as well), I feel that I should offend you at least once, or I am not doing my job. But, any offense is meant in the spirit of the great Romantic poet William Blake who taught us that “Opposition is true friendship.”
My Surprises are shorter in length than in previous years. (I want to quickly get to the important points of the Surprise List – available on one or two pages – rather than deliver a more flowery prose and bunch of stories that I have commonly done in the past).
We will start the new investment year about one month from now with a completely different “feeling” of previous years – as I mentioned previously, the complexion of Mr. Market seems to have changed:
- Investors (retail and institutional), previously comfortable being among the herd of optimism, are beginning to panic.
- The dominant investors of the decade – Exchange Traded Funds and Quantitative Strategies and Products (e.g. risk parity) – are selling into weakness (just as they bought into strength) – serving to overwhelm active investors.
- Hedge funds are completing another unfavorable year in which their investment performance is poor. Against a backdrop of a high fee structure (at a time in which passive management fees are “moving to zero” ) – redemptions are growing and even some of the most competent managers are hanging up their spikes and closing down.
- Public companies, in some measure to increase the value of their stock options) who have gone on a massive buying streak of their own securities (propping up stocks and nominal EPS at the expense of building their businesses and improving productivity) may begin to get second thoughts as stocks founder and interest rates have risen.
- The two “shiny objects” crypto currency and FANG – revered and hyped by the many – is likely having a more profound impact on the herd’s newly found negative sentiment than many realize.
- Global economic growth prospects continue to grow more ambiguous – with the schmeissing of the price of crude oil another warning and conspicuous signpost of a broadening slowdown.
- The Federal Reserve has made a profoundly important change from easing to restraint.
“In ambiguous situations, it’s a good bet that the crowd will generally stick together — and be wrong.” – Doug Sherman and William Hendricks
The core themes and roadmap for 2019 is that a standard run-of-the-mill Bear Market may run into something bigger in a year enveloped in unprecedented political turmoil (and electorate disgust and anger), an escalating trade (and cold) war with China and continuing global economic disappointments — dragging down a mature, an extended and fully exploited economic growth and market cycle.
Not surprisingly, my Surprise is that a slightly down year of performance for the S&P Index in 2018 may turn out to be something worse in 2019.
But the biggest and most provocative surprise is the decline and fall of President Trump in 2019 – in which an anti-imperial rebalancing is successfully mounted by a more assertive Congress, bringing the country back into constitutional equilibrium.
Without further fuss, here are my outside of consensus 15 Surprises for 2019:
1) A U.S. Recession in 2019 Followed by Stagflation:
We learn, in 2019, the extent to which economic activity was pulled forward by the protracted period of historically low interest rates – as capital spending, retail sales, housing and autos founder further.
With U.S. Real GDP growth dropping to +1% to +2% in the first half of 2019, inflation remaining stubbornly high (especially of a wage-kind as the labor market remains tight) and with cost pressures unable to be passed on, the threat of recession intensifies.
By the third quarter of 2019 U.S. Real GDP turns negative. Tax collections collapse as government spending continues to rise. The budget deficit forecasts are lifted to over $2 trillion.
The U.S. falls into a recession in the last half of 2019 – followed by a lengthy period of stagnating economic growth and higher inflation (stagflation).
A dysfunctional, non-unified and discombobulated Europe also falls into a recession in 2019 – with significant ramifications for U.S. multinationals that populate the S&P Index.
U.S./Chinese trade tensions push the global economy down the hill as the year progresses and GDP growth in China comes in below +5.0%. The IMF reduces it’s global economic growth forecast three times next year.
S&P per share earnings fall by over -10% in 2019.
2) The Federal Reserve Pauses and Then Cuts as Currencies and Interest Rates Swing Wildly:
It’s a wild year for fixed income and currency volatility.
The Fed cuts rates in 3Q2019 and by year-end announces that QE4 will commence in January, 2020.
The 2018 tantrum in Italian bonds is just a precursor for hissy fits throughout the European bond market as the ECB is no longer expanding its balance sheet and tries to get out of NIRP.
The BoJ throws in the towel on their drive for higher inflation. The Japanese bond market sees sharp selloff.
During 2019 the yield on the ten year U.S. note falls to 2.25% before ending the year at over 3.50% as the selloff in European and Japanese bonds and the announcement of QE4 drive our yields higher. Gold falls to $1050 before ending the year at over $1700.
3) Stocks Sink:
Though the third year of a Presidential cycle is usually bullish – it’s different this time.
Trump confusing brains with a bull market can’t fathom the emerging Bear Market. At first he blames it on Steve Mnuchin, his Secretary of Treasury (who leaves the Administration in the middle of the year). Then he blames a lower stock market on the mid-term election which turned the House. Then he blames the market correction on the Chinese.
The S&P Index hits a yearly low of 2200 in the first half of the year as the market worries about slowing economic and profit growth and a burgeoning deficit/monetization. The announcement of QE4 results in a year end rally in December, 2019. In a continued regime of volatility (and in a market dominated by ETFs and machines/algos), daily swings of 1%-3% become more commonplace. Investor sentiment slumps as redemptions from exchange traded funds grow to record levels. The absence of correlation between ETFs and the underlying component investments causes regulatory concerns throughout the year.
Congress holds hearings on the changing market structure and the weak foundation those changes delivered during the year.
Short sellers provide the best returns in the hedge fund space as the S&P Index records a second consecutive yearly loss (which is much deeper than in 2018).
As the Fed cuts interest rates the US dollar falls and emerging markets outperform the US in 2019.
I, like many, are concerned about corporate credit (See Surprise #8) and though credit is not unscathed, it is equities that bear the brunt of the Bear since they are below credit in the company capitalization structure.
Bottom line, after a steep drop in the first six months of the year, the markets rise off of the lows late in the year in response to this shifting political scene (the decline of Trump) and a reversal to a more expansive Fed policy – ending the year with a -10% loss.
4) Despite the Appearance of the Bear, FANG Stocks Surprisingly Prosper (Both Absolutely and Relatively) as Investors Seek Growth (at any cost) In a Slowing Economy – Facebook’s Shares Rebound Dramatically:
While there is a growing consensus that FANG will lead a Bear Market lower – that is not the case as growth, in a general sense, is dear and cherished by market participants next year. Among FANG, Facebook’s shares have a reversal of fortune (and is the best performing FANG stock) as the company announces aggressive management changes and moves to remedy the misinformation trap.
As more previously unrevealed information reduces her valuation, Sheryl Sandburg’s special status as a female leader (in a seascape of men at Facebook and in industry) is questioned. In the first half of 2019, Sandberg becomes a sacrificial lamb and is sacked – and is forced to lean out after leaning in.
At the suggestion of Warren Buffett (who has accumulated a sizable stake in the company), former Board Member Donald Graham is named as the new, independent and Non-Executive Board Chairman of Facebook.
This unexpected move encourages FB investors to believe that the company is quickly moving to fix its multiple data and privacy issues.
Fewer (than feared) Facebook members opt out and growth in usage resumes in the back half of 2019.
FB’s stock popularity (and market capitalization) increases as it becomes a more dominant holding in “value investors” portfolios – the shares trade above $200/share late in the year.
5) “Peak Trump” – the President Bows Out in His Pursuit of a Second Term:
The President’s dismissal of the murder of Washington Post reporter Jamal Khashoggi is seen as delivering tacit support to Saudi Arabia’s MBS – it is a pivotal turning point in Trump’s popularity and ultimate reputational decline in 2019. “Pay enough and you can get away with murder” becomes the mantra of the Progressive Left. Trump acceptance by his Republican party peers quickly diminishes as they are further worried about his motivation to side against the findings of his own intelligence department. After Trump’s personal dealings with authoritarian and autocratic countries are revealed in the Mueller probe (along with possible emoluments violations), Trump’s popularity fades further as Lindsay Graham and other prominent Republicans repeal their support and denounce the President.
An anti-imperial rebalancing is mounted, in which a more assertive Congress brings the country back into constitutional equilibrium.
Though the public and political leaders (even on the right) increasingly reject the President, there are no impeachment efforts by the Democrats. Instead (and surprisingly), House Speaker Pelosi (recognizing that constructive steps are the recipe for a Democratic 2020 Presidential win) exacts discretion and stops the Democrats from moving on an impeachment in the House. Democratic leadership turns to reforms and a torrent of new legislation in the areas of improving the environment and climate control (and the halt of growth in fossil fuel by the development of alternative energy programs), the opioid crisis, education, crime, voting rights, healthcare and prescription drug prices, immigration, etc.- showing the electorate that their Party can demonstrate the framework for a positive agenda, a vision and a social contract (and can rule instead of obstruct).
But, most importantly… With real GDP turning negative in 2019’s second half, Democrats attempt to replace Republicans’ supply-side economics with a smarter theory of growth. Recognizing just as inflation and other ills opened the door for criticism of Keynesian economics in the 1970s, so have inequality and disinvestment done the same for critiques of supply side today. In 2019, the Democrats turn the table on the supply-siders and give a voice through thoughtful proposed legislation (making the affirmative case for the Democratic theory of growth geared to raising wages and putting more money in the hands in working- and middle-class people’s pocket and investing in their needs). Americans enthusiastically embrace this alternative (of how the economy works and grows and spreads prosperity) and reject and defeat the long standing Republican economic narrative – seeing it as a better way to spur on the economy (than giving rich people more tax cuts). Asking the question “has it worked for you?” and given the fairy tale of added revenue from growth (and the widening hole in the deficit), rampant inequality, the fear of being bankrupted by medical catastrophe and massive student debt obligations Democrats provide a practical alternative to cutting taxes for the rich and decreasing regulation which has failed to unleash as much innovation and economic activity that was promised by the Administration. The legislation, which puts more money in middle class pockets, defends and supports the notion that the public sector can make better decisions than the private sector. Referred to as the “middle – in economic bill,” is cosponsored by a leading, conservative and respected Republican member of Congress and begins to gain bipartisan support in Congress, driving a stake through the supply-side’s heart.
Despite his loss of popularity (which plummets to 25%) and the push back from the Republican establishment, Trump declares he is still planning to run for President. Nevertheless, a challenge from Senator Mitt Romney (who’s motto is “Make Republicans Great Again”) gains steam as McConnell, Graham, Kennedy Et al. throw their support for the Senator.
As Trump’s problems multiply, Romney becomes the heavy favorite to defeat Trump in the Republican primary.
Recognizing a sure election defeat, by year-end the President announces that his medical team has disclosed a health issue and he is advised not to run for office. Reluctantly, Trump agrees and bows out of the 2020 Presidential race late in the year.
The Trump mantra of “Make America Great Again” is replaced by “Make Economic Uncertainty and Market Volatility Great Again.”#MAGA/#MUVGA
6) The Year of the Woman:
With a Trump withdrawal from 2020 the election is wide open.
The arc of history influences the Democratic Presidential nomination march and the leading candidates that emerge for 2020 are mostly women. The potential contenders include progressive firebrands like Elizabeth Warren, Stacey Abrams, Kristen Gillibrand and Kamala Harris, and moderates like Senator Amy Klobuchar and Rhode Island Governor Gina Raimondo.
Michael Bloomberg, Howard Schultz and Joe Biden bowout from the race by year end 2019 By year-end, Klobucher, Harris and Warren surface as the three leading Democratic Presidential candidates.
It appears that an all women Democratic ticket (President/Vice President) is increasingly likely.
Nationally, several high profile sexual harassment suits are disclosed. Allegations against a number of well known television, other entertainment and political icons/leaders serve to reinforce the candidacy of the above women who aspire to gain the Democratic Presidential nomination. After Congressional hearings, non partisan and strict harassment legislation are introduced forcing several well known male politicians to resign from office.
7) A New (But Old) Shiny Object Appears As A Stock Market Winner in 2019:
Bitcoin trades close to $3,000 in December, 2018 and spends most of 2019 under $5,000 (as numerous trading irregularities, thefts and more frauds are exposed).
England’s Financial Conduct Authority (FCA) takes the lead, in instituting a comprehensive regulatory response to regulating the crypto currency markets. The U.S. follows by imposing broad-based crypto currency regulation in 2019.
A leading business network (who’s bitcoin “bug” has become the new cover of magazine contrary indicator!) faces a class action suit for their seeming encouragement in buying into the asset class in their too frequent broadcasts during 2018. Several crypto currency guests who were prominent on the network’s coverage are indicted for fraud. In an agreement with regulatory authorities, the biz network’s programming is reconstituted.
Marijuana stocks, after a weak final few months in 2018 (are down by over 50% from their highs), explode back to the upside reflecting a quickened pace of alternative health applications. (MJ) is the single best performing exchange traded fund and (TLRY) makes another move to $300/share.
8) Private Equity, High Yield Debt and Leveraged Loan Problems (Which Have Doubled in Size Over the Last Ten Years) Emerge as the Resurgence of Leveraged Finance Comes to An End:
Private equity, in particular, the biggest winner in the decade long cycle since The Great Decession of 2007-09, suffers – and so do the endowments at several prestigious universities. Covenant- lite financings in junk and leveraged loans – often in opaque and complex structures – topple under the weight of loan defaults. (HYG) (last sale: $83.17) trades $75-$80 as redemptions spike.
Publicly-held private equity shops (KKR) and Blackstone (BX) are among the largest percentages losers in 2019, High yield bonds fulfill their characterization as “junk,” and are among the worst performing asset classes. The spread between junk bonds and Treasuries more than doubles – widening dramatically during the summer months.
9) The China/U.S.Rift Intensifies as Trump’s Anger Shifts Towards That Region:
The trade war with China goes into full effect with 25% tariffs. Walmart (WMT) is adversely impacted and its shares fall by -20% from the recent highs. The Chinese retaliate against major American brands like Apple (AAPL) . (“Peak Apple” actually happens and its shares fall below $125/share).
Peter Navarro resigns.
A major cyber-attack against the U.S. financial system, who’s source is initially not diagnosed, is ultimately reportedly to have been delivered by China. The U.S. enters a cold war with China that resembles the emergence of the cold war with Russia in 1948 – it becomes clear it will be lengthy, nasty and unfriendly to the trajectory of worldwide economic growth.
10) Bank Stocks Are Surprising Winners in 2019:
Despite some pressure in net interest margins (and income), sluggish loan demand and a pickup in loan losses – bank stocks (and EPS) are surprisingly resilient and manage to have a positive return next year as better relative EPS growth is supported by aggressive buybacks and (starting) low valuations. Investors look forward to a recovery in economic growth in 2020-21 and bank stocks (flat for most of the year) have a vigorous move in the last few months of the year and are one of the few sectors to advance in 2019.
Oil stocks, depressed from the late 2018 crude oil price fall also recovery mightily in the later months of 2019 as the price of oil advances coincident with dovish turn in monetary policy.
11) Tesla’s Problems Shift From Production to Demand to Financial:
Tesla (TSLA) loses its tax subsidy in the U.S. and in the Netherlands (a large market for them).
European competition grows.
Europe doesn’t allow the Tesla Model 3 due to safety reasons. The Chinese won’t let an American company have video data over millions of miles of roads and bans Tesla. Lenders balk and access to the public debt market evaporates. The company’s financial position deteriorates and its credit default swaps widen dramatically.
An accounting “issue” surfaces – and it morphs into an accounting fraud. Elon Musk, who has leveraged his TSLA equity holdings, faces margin calls and is forced to sell Tesla shares.
After being rushed to the hospital after an overdose, Musk leaves his CEO post to enter drug rehab.
12) Berkshire Hathaway (BRK.A) (BRK.B) Announces the Largest Takeover in History – The Transformational Acquisition of 3M for $150 billion.
13) Amazon (AMZN) Makes a Bid for Square (SQ) but Alphabet/Google (GOOGL) Eventually Acquires Both Square SQ and Twitter (TWTR)
14) With its Share Price Consistently Trading Under Its Book Value During the First Few Months of 2019, Goldman Sachs’ (GS) Partners Take the Brokerage Private in a Leveraged Buyout at $238/share.
15) Brexit Happens: The world continues and the pound is the best global currency.
Here Are 5-“Also Eligible” Surprises:
- AE1) Ford (F) defaults on its loans. Steve Rattner again becomes the “car czar.”
- AE2) A major and unexpected global event judged to be impacted by climate issues causes a massive amount of health problems and deaths. Demand for a reversal of Trump policy on climate change comes from his within his own Party and represents another fissure between the White House and the legislative branch.
- AE3) Warren Buffett announces his successor. The name, however, is no surprise.
- AE4) Angela Merkel doesn’t make it thru the year and Germany has a new leader.
- AE5) As is typical with maturing economic cycles, two large accounting frauds of S&P Index constituents are uncovered late in the year. A previously “sainted” and revered CEO does a prep walk.
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