Below is Doug Kass – 15 Surprises for 2019. Doug Kass is a Founder ​ and President ​ of Seabreeze Partners Management Hedgefund.

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)

Policy:
“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 Economy:
“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

The Markets:
“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.

See the link below for the annual investor letters.

Here are some of the highlights:

1. Deal-making CEOs
In explaining why he thinks it’s so difficult to find stand-alone companies to buy at a “sensible” price, Buffett blames a buying frenzy driven in part by overly eager corporate managers who are egged on by their boards:
“If Wall Street analysts or board members urge that brand of CEO to consider possible acquisitions, it’s a bit like telling your ripening teenager to be sure to have a normal sex life.”

2. On leverage and sleeping well
“Our aversion to leverage has dampened our returns over the years. But Charlie and I sleep well. Both of us believe it is insane to risk what you have and need in order to obtain what you don’t need.”

3. Stop on in
Buffett touts one of the deals Berkshire did get done in 2017, its acquisition of a 38.6% partnership interest in travel-center operator Pilot Flying J, or PFJ. He offers this plug:
“When driving on the Interstate, drop in. PFJ sells gasoline as well as diesel fuel, and the food is good. If it’s been a long day, remember, too, that our properties have 5,200 showers.”

4. Liquidity and the ‘kindness of strangers’
In a discussion of Berkshire’s insurance float—the pool of money collected from premiums but not yet paid out in claims—Buffett talks about the desire for ample liquidity:
“Charlie and I never will operate Berkshire in a manner that depends on the kindness of strangers—or even—that of friends who may be facing liquidity problems of their own. During the 2008-2009 crisis, we liked having Treasury bills—loads of Treasury bills—that protected us from having to rely on funding sources such as bank lines or commercial paper.
“We have intentionally constructed Berkshire in a manner that will allow it to comfortably withstand economic discontinuities, including such extremes as extended market closures.”

5. ‘In America…’
Buffett regularly argues that the very long-term outlook for the U.S. economy—and stocks SPX, -1.27% —is undeniably bullish:
“Charlie and I view the marketable common stocks that Berkshire owns as interests in businesses, not as ticker symbols to be bought or sold based on their ‘chart’ patterns, the ‘target’ prices of analysts or the opinions of media pundits. Instead, we simply believe that if the businesses of the investees are successful (as we believe most will be) our investments will be successful as well. Sometimes the payoffs to us will be modest; occasionally the cash register will ring loudly. And sometimes I will make expensive mistakes.
“Overall—and over time—we should get decent results. In America, equity investors have the wind at their back.”

6. Watch those fees
Buffett is a stock picker, but he’s adamant most investors are better off sticking with passive, low-cost, index-tracking products. In a section where he again bashes Wall Street and hedge funds, he reminds:
“Performance comes, performance goes. Fees never falter.”

7. ‘Willingness to look foolish’
“Though markets are generally rational, they occasionally do crazy things. Seizing the opportunities then offered does not require great intelligence, a degree in economics or a familiarity with Wall Street jargon such as alpha and beta. What investors then need instead is an ability to both disregard mob fears or enthusiasms and to focus on a few simple fundamentals. A willingness to look unimaginative for a sustained period—or even to look foolish—is also essential.”

Here is the full annual Buffett 2017 Letter.

courtesy of Blackstone, Byron R. Wien, Vice Chairman in the Private Wealth Solutions group at Blackstone, issued his list of Ten Surprises for 2018.
Byron’s Ten Surprises for 2018 are as follows:

1. China finally decides that a nuclear capability in the hands of an unpredictable leader on its border is not tolerable even though North Korea is a communist buffer between itself and democratic South Korea. China cuts off all fuel and food shipments to North Korea, which agrees to suspend its nuclear development program but not give up its current weapons arsenal.

2. Populism, tribalism and anarchy spread around the world. In the United Kingdom Jeremy Corbyn becomes the next Prime Minister. In spite of repressive action by the Spanish government, Catalonia remains turbulent. Despite the adverse economic consequences of the Brexit vote, the unintended positive consequence is that it brings continental Europe closer together with more economic cooperation and faster growth.

3. The dollar finally comes to life. Real growth exceeds 3% in the United States, which, coupled with the implementation of some components of the Trump pro-business agenda, renews investor interest in owning dollar-denominated assets, and the euro drops to 1.10 and the yen to 120 against the dollar. Repatriation of foreign profits held abroad by U.S. companies helps.

4. The U.S. economy has a better year than 2017, but speculation reaches an extreme and ultimately the S&P 500 has a 10% correction. The index drops toward 2300, partly because of higher interest rates, but ends the year above 3000 since earnings continue to expand and economic growth heads toward 4%.

5. The price of West Texas Intermediate Crude moves above $80. The price rises because of continued world growth and unexpected demand from developing markets, together with disappointing hydraulic fracking production, diminished inventories, OPEC discipline and only modest production increases from Russia, Nigeria, Venezuela, Iraq and Iran.

6. Inflation becomes an issue of concern. Continued world GDP growth puts pressure on commodity prices. Tight labor markets in the industrialized countries create wage increases. In the United States, average hourly earnings gains approach 4% and the Consumer Price Index pushes above 3%.

7. With higher inflation, interest rates begin to rise. The Federal Reserve increases short-term rates four times in 2018 and the 10-year U.S. Treasury yield moves toward 4%, but the Fed shrinks its balance sheet only modestly because of the potential impact on the financial markets. High yield spreads widen, causing concern in the equity market.

8. Both NAFTA and the Iran agreement endure in spite of Trump railing against them. Too many American jobs would be lost if NAFTA ended, and our allies universally support continuing the Iran agreement. Trump begins to think that not signing on to the Trans-Pacific Partnership was a mistake as he sees the rise of China’s influence around the world. He presses for more bilateral trade deals in Asia.

9. The Republicans lose control of both the Senate and the House of Representatives in the November election. Voters feel disappointed that many promises made during Trump’s presidential campaign were not implemented in legislation and there is a growing negative reaction to his endless Tweets. The mid-term election turns out to be a referendum on the Trump Presidency.

10. Xi Jinping, having broadened his authority at the 19th Party Congress in October, focuses on China’s credit problems and decides to limit business borrowing even if it means slowing the economy down and creating fewer jobs. Real GDP growth drops to 5.5%, with only minor implications for world growth. Xi proclaims this move will ensure the sustainability of China’s growth over the long term.

Also-rans:

Every year there are always a few Surprises that do not make the Ten because either I do not think they are as relevant as those on the basic list or I am not comfortable with the idea that they are “probable.”

11. Investors recognize that the earnings of companies in Europe, the Far East and the emerging markets are growing faster than those in the United States while the price earnings ratios in those regions are lower than those in America. Global investments become more broadly represented in institutional portfolios.

The Mueller investigation of the 2016 presidential election fails to implicate any members of the Trump family in collusion with Russian operatives.

Artificial intelligence gains visible momentum. Service sector jobs are automated, particularly clerks in legal and finance professions, as well as workers in fast food outlets and healthcare. Economists begin to question the unemployment data because the rate drops below 4% while so many people still appear to be out of work and seeking government assistance.

12. Cyberattacks become more prevalent and begin to affect consumer confidence. A major money center bank suspends deposits or withdrawals for three days because its system is penetrated. Numerous retail organizations report that customer personal information has been obtained by hackers. Those invading corporate information systems appear to be smarter and more innovative than the internal employees protecting the computer data, suggesting that the systems themselves need to be upgraded.

13. The regulatory authorities in Europe and the United States finally get concerned about the creative destruction of Internet-related businesses. As a result of pressure from retailers and traditional media companies, they begin an investigation of anti-competitive practices at Amazon, Facebook and Google. The public begins to think these companies have too much power.

14. The risks in Bitcoin are so great that regulatory authorities restrict trading. Among their concerns are: no regulatory oversight; no safety and soundness measures; no recourse in the event of mistaken or miscalculated transactions; high cyber risk; no deposit insurance. (Risk source: Morgan Stanley.)

How economic machine works

Ray Dalio is the founder of the investment firm Bridgewater Associates, the company is the largest hedge fund in the world with nearly $120 billion under management based in Westport, CT.

Part 1 — Dalio’s Perspective on Deleveraging: Davos from CNBC

Part 2 — Dalio on Policy & Productivity: Davos

http://video.cnbc.com/gallery/?video=3000143315

Soros Interview

http://www.cnbc.com/id/100401701

Byron started the tradition in 1986 when he was the Chief U.S. Investment Strategist at Morgan Stanley. Byron joined Blackstone in September 2009 as a Senior Advisor to both the firm and its clients in analyzing economic, political, market and social trends.
Byron’s Ten Surprises for 2013 are as follows:

1.Iran announces it has adequate enriched uranium to produce a nuclear-armed missile and the International Atomic Energy Agency confirms the claim. Sanctions, the devaluation of the currency, weak economic conditions and diplomacy did not stop the weapons program. The world must deal with Iran as a nuclear threat rather than talk endlessly about how to prevent the nuclear capability from happening. Both the United States and Israel shift to a policy of containment rather than prevention.

2.A profit margin squeeze and limited revenue growth cause 2013 earnings for the Standard & Poor’s 500 to decline below $100, disappointing investors. The S&P 500 trades below 1300. Companies complain of limited pricing power in a slow, highly competitive world economic environment.

3.Financial stocks have a rough time, reversing the gains of 2012. Intense competition in commercial and investment banking, together with low trading volumes, puts pressure on profits. Layoffs continue and compensation erodes further. Regulation increases and lawsuits persist as an industry burden.

4.In a surprise reversal the Democrats sponsor a vigorous program to make the United States independent of Middle East oil imports before 2020. The price of West Texas Intermediate crude falls to $70 a barrel. The Administration proposes easing restrictions on hydraulic fracking for oil and gas in less populated areas and allowing more drilling on Federal land. They see energy production, infrastructure and housing as the key job creators in the 2013 economy.

5.In a surprise reversal the Republicans make a major effort to become leaders in immigration policy. They sponsor a bill that paves the way for illegal immigrants to apply for citizenship if they have lived in the United States for a decade, have no criminal record, have a high school education or have served in the military, and can pass an English proficiency test. Their goal for 2016 is to win the Hispanic vote, which they believe has a naturally conservative orientation and which put the Democrats over the top in 2012.

6.The new leaders in China seem determined to implement reforms to root out corruption, to keep the economy growing at 7% or better and to begin to develop improved health care and retirement programs. The Shanghai Composite finally comes alive and the “A” shares are up more than 20% in 2013, in contrast with the previous year when Chinese stocks were down and some developing markets, notably India, rose.

7.Climate change contributes to another year of crop failures, resulting in grain and livestock prices rising significantly. Demand for grains in developing economies continues to increase as the standard of living rises. More investors focus on commodities as an investment opportunity and increase their allocation to this asset class. Corn rises to $8.00 a bushel, wheat to $9.00 a bushel and cattle to $1.50 a pound.

8.Although inflation remains tame, the price of gold reaches $1,900 an ounce as central bankers everywhere continue to debase their currencies and the financial markets prove treacherous.

9.The Japanese economy remains lackluster and the yen declines to 100 against the dollar. The Nikkei 225 continues the strong advance that began in November and trades above 12,000 as exports improve and investors return to the stocks of the world’s third largest economy.

10.The structural problems of Europe remain largely unresolved and the mild recession that began there in 2012 continues. Civil unrest subsides as the weaker countries adjust to austerity. Greece proves successful in implementing policies that reduce wasteful government expenditures and raise revenues from citizens who had been evading taxes. European equities, however, decline 10% in sympathy with the U.S. market.

“Every year there are always a few Surprises that do not make the Ten because either I do not believe they are as relevant as those on the basic list or I am not comfortable with the idea that they are “probable.” Below are several “also rans” which did not make the Ten Surprises.”
“Also Rans”
11.Having traded below 20 for most of 2012 the VIX Volatility Index surges 33% to 30, providing a bonanza for traders. The decline in the S&P 500 increases market volatility.

12.The Newtown, Connecticut, massacre finally convinces Congress to do something about gun control. As a first step they ban future civilian purchases of automatic weapons, including handguns, with clips of more than ten rounds and require more extensive background checks on all gun purchases. “It should not be easier to buy a gun than rent a car” becomes a slogan.

13.Frustrated by an inability to increase revenues through raising income taxes, Congress begins to consider different approaches. There is more talk of a value-added tax as well as a wealth tax, and these ideas appear to be slowly gathering momentum.

14.Congress decides that high-frequency and other computerized algorithmic-based trading practices are putting the individual investor at a disadvantage. A transaction fee designed to slow down frenetic activity and protect against “flash crashes” and glitches is imposed on intra-day trades.

15.The planet finds itself saturated with technology. Semiconductor companies, software providers, social media favorites and personal computer manufacturers all report disappointing earnings and provide discouraging guidance. They lead the overall market lower. Users finally agree the present state of the art is fast enough and connected enough, and that they have more “apps” than they know what to do with. Apple bucks the trend and trades above $700 as its products continue to enjoy enormous success abroad.

Doug Kass — Partner of Seabreeze Partners posted his 2012 Outlook courtesy of TheStreet.com.

Kass: 15 Surprises for 2012
“Never make predictions, especially about the future.”
— Casey Stengel

While I had a reasonably successful surprise list for 2011, with about half my surprises coming to fruition, the real story was that I achieved something that is almost impossible to accomplish.

My most important surprise (No. 4) was that the S&P 500 would end the year at exactly the same price that it started the year (1257) and that the range over the course of the year would be narrow (between 1150 and 1300).

As explained below, both predictions were remarkably close to what actually occurred.

My Biggest Surprise for 2011 Was Eerily Prescient

As we entered 2011, most strategists expressed a sanguine economic view of a self-sustaining domestic recovery and shared the view that the S&P 500 would rise by about 17% and would end the year between 1450 and 1500 vs. a year-end 2010 close of 1257.

By contrast, I called for a sideways market, stating that the S&P would be exactly flat year over year. To date, that surprise has almost come true to the exact S&P point. Remarkably, at around midday last Friday, Dec. 23, the S&P 500 was trading at 1257 — Friday’s closing price was 1265 — precisely the ending price on Dec. 31, 2010! (There are still four trading days left in the year, so technically the exercise is not yet over.)

A flat year is a much rarer occurrence than many would think. According to The Chart Store’s Ron Griess, in the 82 years since 1928, when S&P data was first accumulated, the index was unchanged in only one year (1947). And in only three of the 82 years was the annual change in the S&P Index under 1% — 1947 (0.00%), 1948 (-0.65%) and 1970 (+0.10%).

In addition to the amazing accuracy of my variant S&P forecast, my forecast for the index’s full-year trading range was almost as precise — in both content and from the standpoint of causality.

As I wrote, a year ago, the S&P 500 would exhibit “one of the narrowest price ranges ever.”

The surprise expected was that the S&P would never fall below 1150 (it briefly sold at 1090) and never rise above 1300 (it briefly traded at 1360), “as the tension between the cyclical tailwind of monetary ease (and the cyclical economic recovery it brings) would be 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.” I went on to write, “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.”

Dueling Annual Surprise Lists: Kass vs. Wien

By means of background and for those new to Real Money Pro, nine 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, who originally delivered his list while chief investment strategist at Morgan Stanley (MS) then Pequot Capital Management and now at Blackstone (BX).

Every year I, and many others, look forward to Byron “Brontosaurus Rex” Wien’s annual compilation (hat tip to “Squawk Box’s” Joe Kernen for giving him the moniker).

Byron has had a remarkable (and almost uncanny) record of his surprises becoming realities ever since he started his exercise back in 1986. His picks in 2009 were particularly accurate, but his surprises for 2010 were considered by some to be off the mark.

Here is Byron Wien’s surprise list for 2011. The tone of almost all of Byron’s 2011 surprises was diametrically opposed to my list — namely, his list was rooted in optimism, while my list was rooted in pessimism. Where I saw slowing and sluggish economic growth, a weak housing market, a European recession by year-end and a lackluster stock market, Byron saw improving prospects. His principal surprises for the economy, interest rates, housing, the eurozone’s debt crisis and the housing markets were off the mark in 2011. (Byron is an honest guy, so he would be the first to admit this.)

Specifically, Bryon expected U.S. real GDP growth of close to 5% (real U.S. GDP over the past 12 months saw only a 1.8% growth rate), a 5% yield on the 10-year U.S. note (which now stands at 2.03%, but, hey, I got that one wrong, too!), a year-end S&P 500 close near 1500 (now at 1265), a sharp recovery in housing starts to 600,000 and a rise in the Case-Shiller Home Price Index, and a quiescent and non-market-disruptive European debt situation. He was very correct on the price of gold (where I was far off base) and on benign inflationary pressures.

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:

1.how wrong conventional wisdom can consistently be;

2.that uncertainty will persist;

3.to expect the unexpected;

4.that the occurrence of Black Swan events are growing in frequency; and

5.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.

Consensus Is Often Wrong

“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’s Top 10 Surprises for 2012” (hat tip to Zero Hedge)

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 , the quality of 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 groupthink (or groupstink, 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 (FNM) and Freddie Mac (FRE), housing’s new paradigm (in the mid-2000s) of noncyclical 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.

“Consensus is what many people say in chorus but do not believe as individuals.”
— Abba Eban (Israeli foreign minister from 1966 to 1974)

In an excellent essay published a year ago, GMO’s James Montier made note of the consistent weakness embodied in consensus forecasts. As he puts it, “economists can’t forecast for toffee.”

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 Montier’s Exhibit No. 4 (above) 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, 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!
— James Montier

How Did Consensus Do in 2011?

As we entered 2011, consensus estimates for economic growth, corporate profits, stock price targets and interest rates were generally optimistic and, as is typical, grouped in an extraordinarily tight range. Last year, I chose to use Goldman Sachs’ (GS) forecasts as a proxy for the consensus. Here were Goldman’s forecasts for 2011, with the likely or actual 2011 full-year returns/results in parentheses:
•2011 U.S. real GDP up 3.4% (up 1.8% actual), and global GDP up 4.7% (up 3.8% actual);

•2011 S&P 500 operating profits of $94 a share ($97 a share actual);

•year-end S&P 500 price target at 1450 (Friday, Dec. 23’s close: 1265 actual);

•2011 inflation (core CPI) of +0.5% (+1.7% actual); and

•2011 closing yield on the U.S.10-year Treasury note at 3.75% (2.03% actual).

How Did My Surprise List for 2011 Fare?

“Those who cannot remember the past are condemned to repeat it.”
— George Santayana

My surprises for 2011 attacked some of the closely grouped and nearly universally optimistic consensus expectations on the part of money managers, strategists, economists and members of the fourth estate. My intention was not to be a Cassandra or to be a contrarian for contrary’s sake but rather to recognize that most prefer the dreams of the future to the history of the past. My surprises embodied an often repeated lesson of history: What seems easy for (bullish) investors to imagine today might prove more difficult to deliver, as prospect is often better than possession.

Looking 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.

Three years ago, only the remnants anticipated anything near the magnitude of the fall in the world’s economies and capital markets, despite what appeared to be clear and accumulating evidence of economic uncertainty and growing credit risks (and abuses). The analysis of multi-decade charts and economic series convinced most (along with other conclusions) that home prices were incapable of ever dropping, that derivatives and no-/low-document mortgage loans were safe, that there was no level of leverage (institutional and individual) too high and that rating agencies were responsible in their analysis. Importantly, they also failed to see the signposts of an imminent deterioration in business and consumer confidence that was to result in the deepest economic and credit crisis since the early 1930s.

I expressed in my list last year that many of those who were expressing the most extreme levels of optimism for 2011 were the most wrong-footed three years ago and experienced not inconsequential pain in the last investment cycle.

Back in 2008-2009 and again last year (but to a far lesser degree), many investors appeared similar to victims of Plato’s allegory of the cave — a parable about the difficulty of people who exist in a world shaped by false perceptions to contemplate truths that contradict their beliefs. This is why so many investors were blindsided by the last economic downturn and, from my perch, continued to remain conditioned to wearing rose-colored glasses in 2011.

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 Philosophy: The Revolution in Modern Science

Last year’s surprise list achieved about a 50% success ratio. Forty percent of my 2010 surprises were achieved, while I had a 50% success rate in 2009, 60% in 2008, 50% in 2007, one-third in 2006, 20% in 2005, 45% in 2004 and one-third came to pass in the first year of my surprises in 2003.

My surprise list for 2011 hit on some of the important themes that dominated the investment and economic landscape this year. Below is a list of some of my accurate surprises from last year’s list.

•Markets: As discussed previously, the market was practically unchanged in 2011, and the year’s range almost perfectly coincided with my No. 4 surprise. Also, group performance surprises were fulfilled — for instance, “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.” I also was correct in expecting asset managers’ shares to fall lower and underperform.

•The U.S. economy: Real GDP in the U.S., as I expected, was disappointing at about half consensus growth expectations. Screwflation of the middle class was a dominant theme, and I incorporated screwflation in my surprise list and in a Barron’s “Other Voices” editorial in June. Americans, I thought, would remain in a foul mood, as the jobs and housing markets failed to improve to the degree expected by most. My surprise of social unrest was also realized around the world — over there in the Arab Spring and over here in the Occupy Wall Street movement.

•The European economy: Over there and as I suggested a year ago, “multiple country austerity programs moved Europe back into recession by year-end 2011.”

•China’s economy: I wrote that “China continues to tighten, but inflation remains persistent, economic growth disappoints and its stock market weakens further.” All happened.

•U.S. politics: I wrote “increased 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…. 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.” Trust in our leaders was indeed lost throughout 2011 — approval ratings hit an all-time low during 2011 for Congress) and for the president — and political gridlock and inertia adversely impacted sentiment as confidence figures plummeted by late summer.

•Republican presidential candidate: Mitt Romney, as expected, is the Republican Party’s presidential frontrunner (but Ryan and Thune never were in the fray).

•Commodity prices: Throughout the year, “the rise in the price of commodities was one of the primary market themes and concerns.”

•Gold: I was correct in expecting volatility in the price of gold but very wrong in the direction of the price of gold when I wrote, “The price of gold plummets by more than $250 an ounce in a four-week period in 2011 and is among the worst asset classes of the new year. The commodity experiences wild volatility in price (on five to 10 occasions, the price has a daily price change of at least $75), briefly trading under $1,050 an ounce during the year and ending the year between $1,100 and $1,200 an ounce.”

•Takeovers: Though Microsoft (MSFT) has not yet made a bid, my Yahoo! (YHOO) deal surprise turned out to be materially correct. “Among the most notable takeover deals in 2011, Microsoft launches a tender offer for Yahoo!…. The private equity community joins the fray.”

•Internet as the tactical nuke of the digital age: “Cybercrime likely explodes exponentially as the Web is invaded by hackers.” Dead on, as serious hacking incidents are occurring with increased frequency.

•Expanding insider trading charges: It was a record year of insider trading indictments and convictions, from Raj to many other ne’er-do-wells (including research network consultants, hedge funds, corporations and even a member of the board of directors of Goldman Sachs). “The SEC’s insider trading case expands dramatically, reaching much further into the canyons of some of the largest hedge funds and mutual funds and to several West Coast-based technology companies.” (Some of us even learned this year for the first time that Congress is legally permitted to be in the insider trading game!)

Where did my surprises for 2011 go wrong?

•Though the price of gold was volatile (and did sustain quick $200-per-ounce drops), it did not fall and was among the best asset classes in 2011.

•There was no military confrontation between China and India over water rights.

•The price of oil didn’t soar to over $125 a barrel.

•The yield on the 10-year U.S. note did not spike to 4.25%.

•Food and restaurant stocks were not among the worst-performing market sectors.

•Hillary Clinton and Joe Biden did not switch jobs, though Clinton is resigning her post as Secretary of State.

•While Speaker of the House John Boehner’s tenure has been uneven, he was not replaced by Paul Ryan.

•A third political party did not appear (though it is never too late!).

•There was no peaceful regime change in Iran.

What Is Consensus for 2012?

As we enter 2012, investors, strategists and talking heads are again grouped in a narrow consensus, but, in contrast with last year’s almost universally bullish views on the economy and on the U.S. stock market, the consensus is far more downbeat, reflecting near universal acceptance of Pimco’s Bill Gross’s “new normal” of de-leveraging, de-globalization and re-regulation.

Again, let’s use Goldman Sachs’ principal views of expected economic growth, corporate profits, inflation, interest rates and stock market performance as a proxy for consensus.

Below are Goldman Sachs’ forecasts for 2012:
•2012 U.S. real GDP up 1.8%, and global GDP up 3.2%;

•2012 S&P 500 operating profits of $100 a share;

•year-end 2012 S&P 500 price target at 1250;

•2012 inflation of +1.7%; and

•2012 closing yield on the U.S.10-year Treasury note at 2.50%.

My 15 Surprises for 2012

“More than any other time in history, mankind faces a crossroads. One path leads to despair and utter hopelessness. The other to total extinction. Let us pray we have the wisdom to choose correctly.”
— Woody Allen

Ever since 2007, my contrarian and variant surprise lists were almost always downbeat relative to consensus. I adopted a Kafkaesque sense of hopelessness and an almost Woody Allen-like sense of foreboding (see quote above). It was as if I was giving a traffic report from the perspective of chronicling the automobile accidents on I-95.

You’ll be swell! You’ll be great!
Gonna have the whole world on the plate!
Clear the decks! Clear the tracks!
You’ve got nothing to do but relax.
Blow a kiss. Take a bow.
Honey, everything’s coming up roses!
— Stephen Sondheim and Jule Styne, “Everything’s Coming Up Roses”

But, my new surprises for 2012 represent a fundamental turn toward optimism and a marked departure from the pessimism expressed in my recent surprise list history — as I move metaphorically from the Broadway stage of Woody Allen’s 1966 play Don’t Drink the Water to Stephen Sondheim and Jule Styne’s 1959 Broadway musical Gypsy’s “Everything’s Coming Up Roses” (see lyrics above).

For the last few years, since the financial and economic crisis of 2008-2009, caution, restraint and the word “no” have characterized and dominated the economic, social and political backdrop. In 2012, however, our surprise list moves toward an inflection point in which bolder steps, expansiveness and the word “yes” begin to dominate the political, economic and stock market stages.

This new, brighter and more positive narrative is the essence and the common thread contained in my surprise list for 2012. (And this year, following each surprise, I am introducing a specific strategy that might be employed in order for an investor to profit from the occurrence of these possible improbables).

Surprise No. 1: The U.S. stock market approaches its all-time high in 2012. The beginning of the New Year brings a stable and range-bound market. A confluence of events, however (discussed further in the body of the 15 Surprises for 2012), allows for the S&P 500 to eclipse the 2000 high of 1527.46 during the second half of the year. The rally occurs as a powerful reallocation trade out of bonds and into stocks provides the fuel for the upside breakout. The market rip occurs in a relatively narrow time frame as the S&P 500 records two consecutive months of double-digit returns in summer/early-fall 2012.

Strategy: Buy out-of-the-money SPDR S&P 500 ETF Trust (SPY) calls.

Surprise No. 2: The growth in the U.S. economy accelerates as the year progresses. The U.S. economy muddles through in early 2012, but, with business, investor and consumer confidence surging in the fall, real GDP accelerates to over 3% in the second half. Unemployment falls slightly more than consensus, but the slack in the labor market continues to constrain wage growth. Domestic automobile industry sales soar well above expectations, benefiting from pent-up demand and an aging U.S. fleet. Inflation is contained but begins to be worrisome (and serves as a market headwind) in late 2012. Corporations’ top-line growth is better than expected, and wage increases are contained. Operating margins rise modestly as sales growth lifts productivity and capacity utilization rates. Operating leverage surprises to the upside as 2012 S&P profits exceed $105 a share.

A noteworthy surprise is that the residential real estate market shows surprising strength. The U.S. housing market becomes much bifurcated (in a market of regional haves and have-nots), as areas of the country not impacted adversely by the large shadow inventory of unsold homes enjoy a strong recovery in activity and in pricing. The Washington, D.C., to Boston, Mass., corridor experiences the most vibrant regional growth, while Phoenix, Las Vegas and areas of California remain weak. The New York City market begins to develop a bubbly speculative tone. Florida is the only area of the country that has had large supply imbalances since 2007 that experiences a meaningful recovery, which is led by an unusually strong Miami market.

Strategy: Buy Home Depot (HD), Lowe’s (LOW), building materials and homebuilders, and buy auto stocks such as Ford (F) and General Motors (GM).

Surprise No. 3: Former Presidents Bill Clinton and George Bush form a bipartisan coalition that persuades both parties to unite in addressing our fiscal imbalances. The Clinton-Bush initiative, also known as “Simpson-Bowles on steroids,” gains overwhelming popular support, and despite strenuous initial opposition, it forces the Democrats and Republicans (months before the November elections) to move toward a grand compromise on fiscal discipline and pro-growth fiscal policy. Interest rates remain subdued, growth prospects become elevated and a feel-good atmosphere begins to permeate our economy in a return of confidence and in our capital markets engendered by the Clinton-Bush initiative.

The Clinton-Bush initiative includes seven basic core policies that are accepted by both political parties.
1.A broad infrastructure program focused on a massive build-out and improvement of the U.S. infrastructure base — the restoration of our country’s highways, bridges and buildings and an extensive internet bandwidth expansion are embarked upon.

2.The annual increase in government spending is limited to the change in the CPI.

3.A comprehensive jobs plan includes new training programs — all veterans are made eligible to tuition subsidies to vocational schools and colleges.

4.A Marshall Plan for housing is introduced, highlighted by a nationwide refinancing proposal adopted for all mortgagees (regardless of loan-to-values).

5.A series of new tax increases, including a plan to raise taxes on the families with an income in excess of $500,000 a year (a two-year income tax surcharge of 5%-10%) and some other more imaginative, outside-the-box proposals (e.g., a tax on sugar products) are introduced.

6.Mean test entitlements, freeze entitlement payouts and gradually increase the Social Security retirement age to 70 years old.

7.A comprehensive plan is designed to rapidly develop all our energy resources.

Strategy: See No. 1 surprise strategy. Sell volatility.

Surprise No. 4: Despite the grand compromise, the Republican presidential ticket gains steam as year progresses, and Romney is elected as the forty-fifth President of the United States. The U.S. moved to the left politically in the Democratic tsunami in 2008 and to the right politically as the Republican Party gained control of Congress in 2010; the 2012 election is the tiebreaker. The result of the tiebreaker is that Mitt Romney and Marco Rubio squeak by Barack Obama and Joseph Biden in the November 2012 election. All the five swing battleground states (Florida, Indiana, Missouri, North Carolina and Ohio) go Republican. The Romney-Rubio ticket also wins the states of New Hampshire and Virginia, previously won by Obama in 2008, and the Republicans prevail (270 electoral votes to 268 votes) in one of the closest elections of all time. (Here is a great interactive electoral college map that allows you to make your own predictions.)

Strategy: See No. 3 surprise strategy.

Surprise No. 5: A sloppy start in arresting the European debt crisis leads to far more forceful and successful policy. The EU remains intact after a brief scare in early 2012 caused by Greece’s dissatisfaction (and countrywide riots) with imposed austerity measures. The eurozone experiences only a mild recession, as the ECB introduces large-scale quantitative-easing measures that exceed those introduced by the Fed during our financial crisis in 2008-2009.

Strategy: Buy European shares. Buy iShares MSCI Germany Index Fund (EWG) and iShares MSCI France Index Fund (EWQ).

Surprise No. 6: The Fed ties monetary policy to the labor market. In order to encourage corporations to invest and to build up consumer and business confidence, the Fed changes its mandate and promises not to tighten monetary policy until the unemployment rate moves below 6.5%, slightly above the level at which wage pressures might emerge (the Non- Accelerating Inflation Rate of Unemployment).

Strategy: Buy high-quality municipal bonds or the iShares S&P National AMT – Free Municipal Bond Fund (MUB).

Surprise No. 7: Sears Holdings declares bankruptcy. In a spectacular fall, Sears Holdings (SHLD) shares are halted at $18 a share during the early spring, as vendors turn away from the retailer, owing to a continued and more pronounced deterioration in cash flow (already down $800 million 2011 over 2010), earnings and sales. With funding and vendor support evaporating, as paper-thin earnings before interest and taxes margins turn negative and cash flow is insufficient to fund inventory growth. The shares reopen at $0.70 after the company declares bankruptcy and its intention to restructure, as we learn, once again, that being No. 3 in an industry has little value — especially after store improvements were deferred over the past several years. A major hedge fund and a large REIT join forces in taking over the company. Ten to fifteen percent of Sears’ 4,000 Kmart and specialty stores are closed. More than 35,000 of the company’s 317,000 full-time workers are laid off. As a major anchor tenant in many of the nation’s shopping centers and with no logical store replacement, the REIT industry’s shares suffer through the balance of the year, and the major market indices suffer their only meaningful correction of the year. Target (TGT) and Wal-Mart’s (WMT) shares eventually soar in the second half of 2012.

Strategy: Buy out-of-the-money Sears Holdings puts, go long Target and Wal-Mart, and short the iShares Dow Jones U.S. Real Estate Index Fund (IYR).

Surprise No. 8: Cyberwarfare intensifies. Our country’s State Department’s defenses are hacked into and compromised by unknown assailants based outside of the U.S. Our armed forces are place on Defcon Three alert.

Strategy: None.

Surprise No. 9: Financial stocks are a leading market sector. After five years of underperformance, the financial stocks rebound dramatically and outperform the markets, as loan demand recovers, multiple takeovers permeate the financial intermediary scene and domestic institutions enjoy market share gains at the expense of flailing European institutions. With profit expectations low, three years of cost-cutting and some revenue upside surprises (from an improving capital markets, a pronounced rise in M&A activity and better loan demand) contribute to better-than-expected industry profits. P/>

Another tough year
To cover this group
Down 40 to 50
And they’re still in the soup
Regulation, litigation
And potential mitigation
Time to put it all aside
And enjoy your vacation….

But if Republicans win the White House
It’s them I’d like to thank
Cause they’ll not only change the top seat
But also the bill of Mr. Dodd and Mr. Frank

So Happy New Year
Hope you found this rap a little clever
And buy some big banks and brokers next year
Don’t hide in the regionals forever!

— “Nomura Securities’ Year-End Rap”

Strategy: Buy JPMorgan Chase (JPM), Citigroup and the Financial Select Sector SPDR (XLF).

Surprise No. 10: Despite the advance in the U.S. stock market, high-beta stocks underperform. Though counterintuitive within the framework of a new bull-market leg, the market’s lowfliers (low multiple, slower growth) become market highfliers, as their P/E ratios expand.

With the exception of Apple (AAPL), the highfliers — Priceline (PCLN), Baidu (BIDU), Google (GOOG), Amazon (AMZN) and the like — disappoint. Apple’s share price rises above $550, however, based on continued above-consensus volume growth in the iPhone and iPad. Profit forecasts for 2012 rise to $45 a share (up 60%). In the second quarter, Apple pays a $20-a-share special cash dividend, introduces a regular $1.25-a-share quarterly dividend and splits its shares 10-1. Apple becomes the AT&T (T) of a previous investing generation, a stock now owned by this generation’s widows and orphans.

Strategy: Long Apple (common and calls).

Surprise No. 11: Mutual fund inflows return in force. With confidence renewed, domestic equity inflows begin to pour into equity mutual funds by midyear and approach a $100 billion seasonally adjusted annual rate by fourth quarter 2012. The share prices of T. Rowe Price (TROW) and Franklin Resources (BEN) double.

Strategy: Long Legg Mason (LM), T. Rowe Price and Franklin Resources.

Surprise No. 12: We’ll see merger mania. Cheap money, low valuations and rising confidence are the troika of factors that contribute to 2012 becoming one of the biggest years ever for mergers and takeovers. Canadian companies are particularly active in acquiring U.S. assets. Canada’s Manulife (MFC) acquires life insurer Lincoln National (LNC), two large banks join a bidding war for E*Trade (ETFC), and International Flavors & Fragrances (IFF) and Kellogg (K) are both acquired by non-U.S. entities. Finally, a Canadian bank acquires SunTrust (STI).

Strategy: Long E*Trade, Lincoln National, International Flavors & Fragrances, Kellogg and SunTrust.

Surprise No. 13: The ETF bubble explodes. There are currently about 1,400 ETFs. During 2012, numerous ETFs fail to track and one-third of the current ETFs are forced to close. There are several flash crashes of ETFs listed on the exchanges. The ETF landscape is littered by investor litigation as investor losses mount. New stringent maintenance rules and new offering restrictions are imposed upon the ETF business. The formation of leveraged ETFs is materially restricted by the SEC. (Hat tip to Barry Ritholtz’s Big Picture.)

Strategy: Avoid all but the largest ETFs.

Surprise No. 14: China has a soft landing (despite indigestion in the property market), and India has a hard landing. India becomes the emerging-market concern. With India’s trade not a driver to GDP growth, its currency in free-fall, pressure to keep interest rates high by its central bank and signs of a contraction in October Industrial Output, India’s GDP falls to mid-single-digit levels.

Strategy: Long iShares FTSE/Xinhua China 25 Index Fund (FXI); short WisdomTree India Earnings Fund ETF (EPI) and iPath MSCI India Index ETN (INP).

Surprise No. 15: Israel Attacks Iran. The greatest headwind to the world’s equity markets is geopolitical, not economic. Israel attacks Iran in the spring, but, at the outset, the U.S. stays out of the conflict. Iran closes the Strait of Hormuz, and oil prices spike to $125 a barrel.

Strategy: Buy Schlumberger (SLB), ExxonMobil (XOM) and other oil production and exploration stocks.

The major indexes (S&P500, Dow Jones & Nasdaq) break above the 200-sma on lower volume.

So far, half way through earnings season, roughly 78% of the S&P 500’s companies have beaten their earnings estimates. Two out of three companies have beaten sales estimates.

Raymond James strategiest, Jeff Saut noted “The July Jump has had another endearing feature in that the three consecutive 100-point “up days” in the D-J Industrial Average (DJIA/10465.94) catapulted the Dow above its June closing high of 10450.64 last Monday. Simultaneously, the D-J Transportation Average (DJTA/4422.94) closed above its June high of 4433.60, thus registering a Dow Theory “buy signal,” at least as I interpret Dow Theory. Ladies and gentlemen, a same day confirmation from both averages is a rare event and suggests a fairly powerful “up move” is underway. That said, Dow Theory signals often come after a significant rally (or decline) has already taken place and hence has expended a lot of energy.

Also worth noting is that a number of other Dow Theorists opine an upside signal has not yet been registered. They need a close above the Dow’s April 23rd price of 11204.28, with a confirmation by the Transports above its May 3rd closing high of 4806.01, for a Dow Theory “buy signal” to be rendered. Alas, “listening” to the market is an art, not a science, and Dow Theory is interpreted differently by many practitioners. Nevertheless, by my pencil a “buy signal” has been registered and I am a buyer on weakness with fairly close stop-loss points to manage the risk.

Also noted by Lowry ‘s research “In summary, as the major price indexes have moved sideways since the May 25th low, market conditions have showed clear signs of strengthening, not weakening. While overbought readings on short-term indicators suggest the potential for a near-term pullback, any decline should act only as a temporary setback in the rally from the July 2nd low and is unlikely to represent the next leg of a more prolonged move lower.”

Below are the charts of the S&P500, Dow Jones & Nasdaq.

2010 – Surprises
1. The US economy grows at a 5% real rate and unemployment drops below 9%.
2. The Federal Reserve hikes the fed funds rate to 2% by year-end.
3. Ten year treasury yields rise above 5.5%.
4. The US dollar rallies against the yen and the euro.
5. The S&P rallies to 1300 in the first half of the year, declines to 1000, then settles around 1115.
6. Japan becomes the best performing market.
7. President Obama endorses nuclear power development.
8. The Obama administration becomes energized via US economic improvement.
9. Financial service legislation will be passed (but in a softer form than originally feared).
10. Civil unrest in Iran peaks.

2009 — 2009
1. The Standard and Poor’s 500 rises to 1200. It made it to 1115. Close enough for me, as it was up over 20% on the year. Given the index bottomed at 666 in March, this rally is clearly related to the stimulus.
2. Gold rises to $1,200 per ounce. It did make that magic number. Again, I see this as a stimulus-related call as there has been a rush into commodities due to worries about dollar weakness on the back of the flood of money from the Fed.
3. The price of oil returns to $80 per barrel. Another accurate prediction. The call he makes here is a more bullish version of my view of a structural supply constraint at present prices. This supply constraint creates price whiplash and forces oil up even in a weak economic environment.
4. The yen goes to 75 and the euro to 1.65. Too dollar bearish. Wien underestimated the weakness of Japan and the Eurozone.
5. The ten-year U.S. Treasury yield climbs to 4%. This too is accurate, as the 10-year made it to 3.93% in June. Obviously, this call was predicated on recovery, which we now have. You should note that Treasuries have really been clobbered since November when the Ten-Year yield reached a low of 3.20%.
6. China’s growth exceeds 7% and its stock market revives. Accurate. Growth was even higher, actually. This prediction, which depended on economic recovery.
7. Falling tax revenues from the financial sector cause New York State to threaten bankruptcy and other states and municipalities follow. This is head-scratchingly bearish given his other views. New York took its lumps, but the real damage was in California (especially given the market-induced tax implications of Wall Street bonuses for New York). This story is not over, though.
8. Housing starts to reach bottom ahead of schedule in the fall, and house prices stabilize after dropping 15% from year-end 2008 levels. The Obama stimulus program proves effective and a slow growth recovery begins before year-end. Third and fourth quarter real gross domestic product numbers are positive. This is what happened.
9. The savings rate in the United States fails to improve beyond 3%, as most economists expect. The concept of thrift seems to have vanished from American culture. Peak job insecurity and negative growth drive increased savings early in the year, but spending resumes as the economic growth turns positive in the second half, making Christmas 2009 the best ever. Exactly.
10. Barack Obama …meaningfully increases U.S. military presence… In a hawkish speech he states that the threat of terrorism forces the United States to maintain a strong military force in this strategic area. Pretty much on the money.

Doug Kass’ Predictions For 2010
Hedge fund manager, noted short seller, and financial columnist Doug Kass is out with his annual list of predictions for the impending year. We covered his 2009 predictions at the beginning of last year so it’s always interesting to see his picks.

One third of his surprises came true in 2003, nearly 50% of them were true in 2004, almost 50% were true for 2007, and 60% of his 2008 surprise predictions came true. Notably, Kass also pegged the bottom in this year’s market back in March. However, he didn’t truly capture all of the gains as his hedge fund was up 17% for the year last we heard.

Here are his predictions (surprises) for 2010 and keep in mind that he is ‘swinging for the fences’ here:

1. There is a glaring upside to first-quarter 2010 corporate profits: (up 100% year over year) and first-quarter 2010 GDP (up 4.5%). It grows clear that, owing to continued draconian cost cuts, coupled with a series of positive economic releases and a long list of company profit guidance increases in mid to late January and early February, there is a very large upside to first-quarter GDP (up 4.5%) and, even more important, to S&P profit growth (which doubles!). The upside on both counts is in sharp contrast to more muted growth expectations. While corporate managers, economists and strategists raise earnings per share, full-year growth and S&P target estimates, surprisingly, the U.S. equity market fails to respond positively to the much better growth dynamic, and the S&P 500 remains tightly range-bound (between 1,050 and 1,150) into spring 2010.
2. Housing and jobs fail to revive: An outsized first-quarter 2010 GDP (up 4.5.%) print is achieved despite a still moribund housing market and without any meaningful improvement in the labor market (excluding the increase in census workers) as corporations continue to cut costs and show little commitment to adding permanent employees.
3. The US dollar explodes higher: After dropping by over 40% from 2001 to 2008, the U.S. dollar continued to spiral lower in the last nine months of 2009. Our currency’s recent strength will persist, however, surprising most market participants by continuing to rally into first quarter 2010. In fact, the U.S. dollar will be the strongest major world currency during the first three or four months of the new year.
4. The price of gold topples: Gold’s price plummets to $900 an ounce by the beginning of second quarter 2010. Unhedged, publicly held gold companies report large losses, and the gold sector lies at the bottom of all major sector performers. Hedge fund manager John Paulson abandons his plan to bring a new dedicated gold hedge fund to market.
5. Central banks tighten earlier than expected: China, facing reported inflation approaching 5%, tightens monetary and fiscal policy in March, a month ahead of a Fed tightening of 50 basis points, which, with the benefit of hindsight, is a policy mistake.
6. A Middle East peace is upended due to an attack by Israel on Iran: Israel attacks Iran’s nuclear facilities before midyear. An already comatose U.S. consumer falls back on its heels, retail spending plummets, and the personal savings rate approaches 10%. 7. The first-quarter spike in domestic growth is short-lived as GDP abruptly stalls.
8. Stocks drop by 10% in the first half of next year: In the face of renewed geopolitical tensions and reduced worldwide growth expectations, stocks drop as the threat of an economic double-dip grows. Surprisingly, though, the drop in the major indices is contained, and the U.S. stock market retreats by less than 10% from year-end 2009 levels.
9. Goldman Sachs goes private: Goldman Sachs stock drops back to $125 to $130 a share, within $15 of the warrant exercise price that Warren Buffett received in Berkshire Hathaway’s late 2008 investment in Goldman Sachs. Sick of the unrelenting compensation outcry, government jawboning and associated populist pressures, Warren Buffett teams up with Goldman Sachs to take the investment firm private. The deal is completed by year-end.
10. Second half 2010 GDP growth turns flat: The Goldman Sachs transaction stabilizes the markets, which are stunned by an extended Mideast conflict that continues throughout the summer and into the early fall. While a diplomatic initiative led by the U.S. serves to calm Mideast tensions, flat second-half U.S. GDP growth and a still high 9.5% to 10.0% unemployment rate caps the U.S. stock market’s upside and leads to a very dull second half, during which share prices have virtually flatlined (with surprisingly limited rallies and corrections throughout the entire six-month period). For the full year, the S&P 500 exhibits a 10% decline vs. the general consensus of leading strategists for about a 10% rise in the major indices.
11. Rate-sensitive stocks outperform; metals underperform: Utilities are the best performing sector in the U.S. stock market in 2010; gold stocks are the worst performing group, with consumer discretionary coming in as a close second.
12. Treasury yields fall: The yield of the 10-year U.S. note drops from 4% at the end of the first quarter to under 3% by the summer and ends the year at approximately the same level (3%). Despite the current consensus that higher inflation and interest rates will weigh on the fixed-income markets, bonds surprisingly outperform stocks in 2010. A plethora of specialized domestic and non-U.S. fixed-income exchange-traded funds are introduced throughout the year, setting the stage for a vast speculative top in bond prices, but that is a late 2011 issue.
13. Warren Buffett steps down: Warren Buffett announces that he is handing over the investment reins to a Berkshire outsider and that he plans to also announce his in-house successor as chief operating officer by Berkshire Hathaway annual meeting in 2011.
14. Insider trading charges expand: The SEC alleges, in a broad-ranging sting, the existence of 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.
15. The SEC launches an assault on mutual fund expenses: The SEC restricts 12b-1 mutual fund fees. In response to the proposal, asset management stocks crater.
16. The SEC restricts short-selling: The SEC announces major short-selling bans after stocks sag in the second quarter.
17. More hedge fund tumult emerges: Two of the most successful hedge fund managers extant announce their retirement and fund closures. One exits based on performance problems, the other based on legal problems.
18. Pandit is out and Cohen is in at Citigroup: Citigroup’s Vikram Pandit is replaced by former Shearson Lehman Brothers Chairman Peter Cohen. Cohen replaces a number of senior Citigroup executives with Ramius Partners colleagues. Sandy Weill rejoins Citigroup as a senior consultant.
19. A weakened Republican party is in disarray: Sarah Palin announces that she has separated from her husband, leaving the Republican party firmly in the hands of former Massachusetts Governor Mitt Romney. An improving economy in early 2010 elevates President Obama’s popularity back to pre-inauguration levels, and, despite the market’s second-quarter decline, the country comes together after the Middle East conflict, producing a tidal wave of populism that moves ever more dramatically in legislation and spirit. With the Democratic tsunami (part deux) revived, the party wins November midterm elections by a landslide.
20. Tiger Woods makes a comeback: Tiger Woods and his wife reconcile in early 2010, and he returns earlier than expected to the PGA Tour. After announcing that his wife is pregnant with their third child, both the PGA Tour’s and Tiger Woods’ popularity rise to record levels, and the golfer signs a series of new commercial contracts that insure him a record $150 million of endorsement income in 2011.
. The New York Yankees are sold to a Jack Welch-led investor group: The Steinbrenner family decides, for estate purposes, to sell the New York Yankees to a group headed by former General Electric Chairman Jack Welch.