Wednesday, October 22, 2008

Reviewing Our 13 Outlier 2008 Predictions

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Please note - I wrote this entry last night before our now once weekly market crash... hence I was in a somewhat benign mood. Not so much today - despite getting a lot of this action correct; we're certainly suffering like everyone else, but thankfully less so. But still a lot of financial pain despite forecasting much of the disaster and taking a contrary view versus the punditry in financial America a year ago. Sometimes it is hard to believe all these things can come true even if intellectually this is what you believe to happen; we have been programmed to believe these type of things "just can't happen". But they are.

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There is less than a quarter to go in the year - it's been historic, it's been amazing, it is something I hope I never see again in my lifetime. In hedge fund master Doug Kass' tradition I penned 13 Outlier Predictions for 2008; remember unlike my normal "roadmap" which are things I think have a very high probability of happening [Reviewing December 2007's Roadmap & Views] - this list is more outrageous sort of predictions which should have low probability of happening. But if they did (do) happen, one can make some serious money by being the contrary viewpoint. Or at least stroke one's ego ;) So with the year 3/4+ of the way done let's see how we did. Again, we need to recall the backdrop - interest rates were still quite high, oil was ramping up but still in double digits, food inflation was something only Don Coxe and I talked about, Guliani/Clinton was going to be the political story of 08, SocGen was some bank in France that no one though would cause a panic worldwide, et al.

I'll post my prediction in italic and shaded red and then score myself on 10 point scale below. Looking at what I predicted I think my 2009 predictions have no chance of matching the accuracy of 2008. I always say if I could of bought futures on my calls this year I'd be up 50-80%... too bad.

#1 I have been stating since late in the summer I expected the Fed, in a desperate attempt to mimic Uncle Alan's intervention policies, to cut rates to 3.5% by the Spring despite lip service about inflation. By year end as the financial world contracts, and despite raging inflation in things that affect Americans, the Fed cuts rate to 2.75%. The central UK bank follows suit (as fellow 'financial innovators'), and arm twisting gets the Canada central bank to lower rates substantially as well. Only the stubborn European Central Bank holds out, wondering what the heck this world is going too. However, a housing implosion in Spain, causes the ECB to cut rates to some degree during the year, but nowhere near the level of the subprime nation aka USA.

Score: 9/10 - Within weeks of writing this the Federal Reserve went into panic when world markets looked to be imploding (Soc Gen trading error?) - the US Fed has done more than I could of ever imagined - or anyone could ever imagine at the time. Inflation had been raging and the Fed still cut rates. We have seen the UK and Canadian banks follow suit and the stubborn ECB has held out - only in the last round of global interest rate cuts this month did it finally relent. The financial world contracting was the understatement of the decade. The only thing I missed on this one, was I turned out to be too optimistic - we are at 1.5% Fed Funds rate heading for 1% or perhaps 0% in the year ahead (hello Japan!)

#2 Now that 2007 bonuses are secure, financial CEO's start laying the axe down and over 100,000 financial jobs are lost in Q1 2008. Workers are outraged, but CEOs say "well that's how it works" - we get the reward from our dumb decisions, you get the pain. Social acrimony in this country only continues to increase. Another round of major layoffs hits in summer as the spring "housing boom" never materializes. CEO's mention they have to be mindful of 2008 bonuses, and cannot keep carrying "dead wood" such as ... workers. Despite hundreds of thousands of job losses throughout the country through 2008, the unemployment rate only bumps up to 5.2%. George Bush smile knowingly and can point to a "raging bull economy" and wonders what all the complaining is about... anyhow, it's someone else's problem soon enough.

Score: 9/10 - the financial industry losses have come hot and heavy and 100,000 was again conservative but it took longer than I thought. Much of this came in Q2 and Q3 and will continue through Q4 of 2008. So I was correct on another round of layoffs in the summer. The housing boom of spring that pundits promised never did come. Social acrimony has increased significantly (the anger at the bailout bill was the first time I've seen US population angry over something not called abortion or gun rights in a long time) Ok I was a bit tongue in cheek on the unemployment rate hiding the reality - it is STILL way understated but we finally got over 6%.

#3 Food inflation ramps worldwide causing serious issues and front page news in countries across the world. The US central bank says, really who cares, after all its not part of core inflation. Somewhere a defeated Ron Paul exhales loudly and exclaims "If they only had listened to me." Inflation becomes an evil term, and part of the mainstream vocabulary again, even by non investing types.... aka "Milk for $6, what the hell, this is ridiculous inflation". Private equity firms and hedge funds start snapping up farmland in the greater Midwest, as this is the "next great investment front", driving up prices to record levels and sparking talk of a "farmland real estate bubble". Food banks report shortages and inability to feed the poor in the country, as people are finding it too expensive to hand out such an expensive commodity for free. They'd rather give peso donations... err, dollar donations, as its a much more worthless commodity than say, beans. Gold spikes to over $1000, and pawn shops become a huge business as people start selling jewelry to pay for gas and food.

Score: 10/10 - food inflation did ramp worldwide this spring/early summer as we posted story after story about rice worries in Asia, devastation in Haita (mud cakes), and even stories hit America about how people were stocking up on some items at Costco. (see all my posts on food crisis from last spring & summer here) We started reading stories of hedge funds snapping up farmland here and here as I predicted. Food banks are reporting shortage (feel free to google it) Gold spiked to over $1000! Pawn shops are even being touted on Cramer's show. Nice calls here.

#4 Political Scenario A: Not 1, but 2 independent candidates emerge to make an unprecedented 4 horse run to the White House. Ron Paul, after winning every online poll every devised, decides the public swell is too great and he must out of principle run after the Republican party refuses to acknowledge there is a person in their party with the name Ron Paul. Mike Bloomberg announces a candidacy in April 2008, and with the public's utter disgust with the 2 party's incompetence, wins the 4 party election with a 34% majority.

Score: 0/10 - My Bloomberg prediction was based on a Guliani/Clinton aka status quo - type of election. Since two "centrists" ended up winning their party nominations there was no need for someone in the middle like Bloomberg and/or the rising star of Obama would of made it not worth his time. Instead Bloomberg is trying to skirt rules and run for a 3rd term as NYC mayor. Nice!

#5 Political Scenario B: In a stunning comeback, John McCain finishes a respectable 3rd in Iowa, and moves on to win New Hampshire. McCain, not Romney or Guliani, emerges as the anti-Huckabee candidate. A series of primary battles between "experience" and "religion conservatism" break out, with the experience of McCain winning over enough Republicans; especially after the machine that is the Clintons wins the Democrats despite a great run by Obama. After a spring and summer dominated by economic concerns on the political trail, a major terrorist attack in a Western country during the summer, sets in motion the groundwork for a McCain presidency. In a major icing of the cake, Mike Bloomberg is brought in as McCain's VP, setting up a dream ticket and trouncing the conventional wisdom that this election is the Democrats election to lose.

Score: 6/10 - McCain did indeed win New Hampshire and come out of nowhere to win the Republican nomination. I wanted to change my Clinton prediction after the stunning win in Iowa by Obama but it was too late by then. I did say a year ago that the economy would be issue #1, #2, and #3 (not Iraq as everyone was saying at the time). Thankfully we have not had a major terrorist attack on a Western country, and Bloomberg still is not on a ticket. Hey I'm trying to find a place for him - maybe the Cabinet ;)

#6 A major hurricane hits the southern US, spiking crude oil prices to $125 and gas to near $4, in the middle of an economic slowdown. Natural gas prices temporarily spike, hurting profits for corporations for 1 quarter but quickly fall right back as a slowing US economy continues to put a cap on pricing. Coal continues its ascent as voracious appetites for energy across the world continue. The Fed ignores this and says, well it's not part of the core inflation rate so really if a tree falls in a forest and no one is there to hear it, did it really happen. Senior citizens on fixed income and only getting cost of living adjustments equal to government 'official' statistics begin to agitate.

Score: 10/10 - other than a Goldman Sachs analyst and a few peak oil folks who have been calling End of Days for a few decades very few were calling for crude oil $125 and gas $4. A major hurricane did hit after a couple of years of breaks but that just was an exclamation point and in fact at the beginning of the end of peak energy prices. Coal did continue its ascent and made us some serious dollars this year. The Fed did ignore much of this inflation (well they talked about it in statements but did nothing but cut rates) Senior citizens on fixed incomes and lousy cost of living adjustments based on the CPI are agitating as their living standards decrease.

#7 After over 2.5 years of not suffering a down 2% day dating through early 2007, volatility in the stock market takes over as the theme of the year, 2% daily increases and drops become a weekly occurrence. The market suffers its first 20% drop (from Oct 9, 2007 peak) in the first half of 2007 as consensus emerges that "a major slowdown" (which dared not be called a recession due to elections coming), is happening. The first half of 2008 is marked by major downward revisions in 08 estimates and a 'cheap market' doesn't look so cheap. The major terrorist attack in Western country (to try to influence US elections), along with record spike in oil prices due to hurricanes (along with a Google warning - see next post) mark a dramatic bottom in the markets through late summer/early fall. Markets make a dramatic rally off these lows as all the worlds banks coordinate to flood massive infusions into the system (all this money needs to go somewhere) - and in combination a massive wave of foreign investment hits US firms (non financial), driving up equities late in the year. Investors are giddy before realizing a 10% return in equities marked with 9% inflation really only means 1% return, but they clap like seals anyhow. Pundits will claim how resilient the economy is without realizing we are selling off large pieces of it... The market ends the year only down 2.78% as economic based bloggers throughout the world wonder what it takes to make the market ever go down?

Score: 9/10 - Oh my. Volatility returns. I remember saying this lack of even 2% days was so abnormal in 2006 yet it continued. Now 4% days are our quiet days - we've had the biggest up days, the biggest down days, the worst week in history, the worst two weeks, intrday volatility that has never been imagined. The stock market not only suffered a 20% drop from peak, but a 40% drop. A "major slowdown" is occuring and finally acknowledged - I remember reading going into 2008 almost every economic survey was for NO recession. Not to mention even a mild one. I called a dramatic early bottom in late summer/early fall - wow, still waiting on this one but that could be prescient beyond imagine if the Oct 10 bottom holds. I said there would be a dramatic rally (still too early to tell). I said world banks would flood the world with massive infusions - another understatement of the decade - even I did not imagine *this*. I'm still waiting for the massive wave of foreign investment but without credit markets working that might not happen - we still have a few months. Pundits did claim how resilient the economy was - they only began throwing in the towel a few weeks ago. Well my prediction of only being down 3% for the year is going to require a rally for the ages ;)

#8 Google is finally hit by an earnings miss by Q3 2008. It won't be a major miss, but enough to rock psychology. Advertising slowdown, led by US recession... err not a recession but a "slowdown" (its a political year folks), finally hits Google, despite secular growth. Google will be seen as human and a company that is not immune to the business cycle, driving the stock down. Baidu.com will suffer a 40% loss as investors, not realizing Baidu is in China and Google is in the US, think US advertisers will cut their spending with Baidu.com as well. Or maybe it's just too expensive. In a sick twist of fate Yahoo emerges as the best performer in the space as News Corp comes in with a buyout as the stock trades listlessly again in 2008.

Score: 8/10 - Google finally showed its age and the stock has stunk even before the rest of the market was really hit - it's been a laggard almost the whole year. Advertising slowdowns (autos, financial) is hitting major media left and right but Google has weathered better than most. Baidu.com did suffer a 40% loss. Yahoo was NOT the best performer in the space but was a buyout candidate - Microsoft instead of News Corp.

#9 Not 1, not 2, but 3 of the top 12 homebuilders file for bankruptcy after the spring and summer of 2008 see no serious rebound in the real estate market. Bankers, finally seeing the light, stop extending life support to these homebuilders who just continue to build homes no one needs, to create cash flow. This creates a major tradeable low in the homebuilders in the fourth quarter and massive rallies on order of 50% are seen in the remaining players. While the ultimate bottom is still a year away, a great trading opportunity is created. Meanwhile the National Association of Realtors throughout the year pushes out their date of "major rebound in all real estate markets" from January 1, 2008 to March 2008...then May, then July, then September, then November, and then January 1 2009 right at midnight.

Score: 7/10 - I know there have been homebuilders going out of business but I'm not sure if any were in the 9-12th spot. None of the top 6-7 went out for some amazing reason. No serious rebound has been seen in the housing market despite pundits calling "Spring 2008" the big recovery. Still open to possibility of huge fourth quarter homebuilder rally - somehow I doubt it. The National Association of Realtors did keep up their Kool Aid most of the year but even they gave up mid year.

#10 After writing off every kitchen sink in America, the 5 major investment banks, after a poor first half of 2008, stage a massive rally in fall 2008, proving once again the black box rules the world. Goldman Sachs attributes its weak first half of 2008 to "we were too busy in strategy sessions figuring out how many government posts should be filled with ex Goldman executives in the next administration, so our core business of milking the financial system for all it's worth and transferring wealth from middle class to upper class suffered. So while we didn't have our eye on the ball, in a way we were. I mean complete dominance of all parts of the world economy, both economic and political, is important no?" This disclosure will be found on page 143 footnote 17 in the 2008 10K. Goldman executives are named to 53 of the 54 top posts in the McCain/Bloomberg administration. The other goes to Bill Richardson so Republicans can be seen reaching across the aisle and win over the Hispanic vote in 1 fell swoop (Goldman of course advised on this move). Somewhere, Ron Paul screams.

Money center banks suffer another year of disaster with no end in sight. Repeated dead cat bounces prevail but the increasing defaults in auto loans, consumer loans, and the "that's so 2007" mortgage loans continues to puncture them. The Federal Reserve takes
unprecedented actions, buying bad loans and keeping them "until markets return to normal" instead of overnight or for 25 days, etc. Normal doesn't return for 2-3 years. Another 2-3 waves of foreign capital infusion from the Far East and Middle East is needed... but at that point these investors realize these banks really are toxic waste dumps. Citibank trades to $23. Even the best run like Wells Fargo cannot escape the coming defaults by the overextended US consumers. Credit cards become in 2008 what 'subprime mortgages' are in 2007. Defaults rage across the country, and politicians, clueless to what is happening in the real world, haul credit card executives back to Washington to make a circus about their tactics (yet again). After this show and dance to try to impress the peeved electorate they whisper post meeting "I'm not really mad at you, this is just for show - just keep doing what you are doing and please make sure you contribute at least $2300 to my campaign"

Score: 6/10 - Well the investment banks no longer exist - that's problem #1. So not only did they not stage a huge rally after a poor 1st half 2008 the top 5 are all gone; 2 are now just "banks", one is part of JPMorgan, one is part of Bank of America and one is kaput. Goldman Sachs is still busy running the country however. That's an easy prediction every year. Money center banks did have a disastrous year but now a government assisted, taxpayer funded end is "somewhat" in sight. If you have eagle vision. There were some incredible dead cat bounces in the financial space this year but bad loans of all types did continue to crop up. The Federal Reserve did take UNPRECEDENTED action and IS buying bad loans. Heck they are doing everything and the Treasury is right there too. The foreign investors who tried to buy in 2007 finally gave up by spring 2008 seeing it was just a black hole to invest in American banks - so that was accurate. Citibank not only traded to $23, it traded to $13 - when I wrote that Citi had fallen from $55 to $30. Even Wells Fargo could not escape. Credit cards are becoming in 2008 what subprime loans were in 2007. Defaults are raging across the country but politicians have been too busy running executives from every other financial arm to bother dealing with credit card executives. Maybe next year.

#11 Apple continues its run to become the largest market cap stock in the USA, tacking on another 50% to finish at $300 by end of 2008. Steve Jobs puts his pinkie to his lips and cackles like Dr. Evil as he quickly positions Apple to be THE consumer electronic convergence BRAND of our lifetime. Macs quickly approach 10% market share, and consumers in foreign countries flee to Apple as a consumer cult brand like a Nike or Adidas. iPod Touch is a surprise massive hit, and the revenue sharing agreement (on subscriptions) from the iPhones is finally realized as the Trojan horse brilliant idea it is. As worldwide laptop sales burst past desk tops, Apple unveils a new consumer convergence product, something bigger than an iPod but smaller than a laptop, but something so good, so sexy, so necessary, people will want to have it surgically attached to their arms. Apple investors will tell you "I told you so" and "please join the cult", and Apple naysayers will say "just wait until next quarter, it's overpriced I tell ya". Dell announces it is buying Apple brand computers for its corporate headquarters (ok just kidding on that last one)

Score: 2/10 - so very wrong on Apple - instead of $300 its striving for $100. It is becoming the dominant electronic convergence play but fundamentals don't matter. Macs are approaching 10% market share (I believe just under 9%) Revenue sharing agreement on the iPhones is brilliant. There is a new wave of laptops but not yet cool enough to surgically attach to the arm.

#12 China has a raging success in its Olympics, although everyone notices no cars are allowed to drive during the 2 weeks (smog and all). Meanwhile the decoupling effect is proven to be yet another farce by CNBC pundits, and major foreign markets, following the lead of the US market fall in tandem. China Shanghai market drops 30%, and daytrading housewives countrywide panic. Taxi cab drivers go back to driving taxis instead of trading stocks. China's sovereign fund decides to simply keep buying Chinese stocks in a desperate attempt by the government to keep the prices high.

Score: 8/10 - China Olympics were a raging success, and pretty much all business (incl cars) came to a standstill for weeks so smog would clear up. The decoupling effect the pundits screamed about was proven to be a false thesis made up by people who don't deserve to be on TV. Foreign markets have fallen in tandem with the US; in fact more so in 2008. I was too optimistic on China; its down over 60%! Remember at the time I wrote, Chinese stocks in late fall early winter 2007 were as hot as internet stocks circa 1999.

#13 Sports: The Indianapolis Colts travel to Boston for the AFC championship game, and in a stunning victory beat the Patriots 35-34 as .... oh nevermind, we can't get that crazy - I have to retain some credibility.

Score: 1/10 - ok this was a backhanded way at saying the 16-0 Pats would win the Super Bowl. They at least got there. Giants? Giants!?!

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