Posts Tagged ‘Payoffs’
Wednesday, December 29th, 2010
Doug Kass is a leading markets commentator, and writes daily for RealMoney Silver.
“Never make predictions, especially about the future.”
There are five lessons I have learned since my first surprise list for 2003:
1. how wrong conventional wisdom can 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.
Eight 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, then Pequot Capital Management and now at Blackstone. (Here was Byron Wien’s surprise list for 2010.)
Importantly, 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 to consider positioning a portion of my portfolio in accordance with outlier events, with the potential for large payoffs.
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 was 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. 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 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.
In an excellent essay published over the past week, GMO’S James Montier makes note of the consistent weakness embodied in consensus forecasts.
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 Exhibit 4 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, and pretty much everything else. If we add greater uncertainty, as refl ected by the distribution of the new normal, to the mix, then the difficulty of investing based upon economic forecasts is likely to be squared!
For 2011, consensus estimates for economic growth, corporate profits, stock price targets and interest rates are grouped in an extraordinarily tight range. I have chosen to use Goldman Sachs’ forecasts as a proxy for the consensus.
Here are Goldman Sachs’ principal views of expected economic growth, corporate profits, inflation, interest rates and stock market performance:
- 2011 GDP up 3.4% (global GDP up 4.7%);
- 2011 S&P 500 operating profits of $94 a share;
- year-end S&P 500 price target at 1,450 (a gain of about 15%);
- 2011 inflation of 0.5%; and
- the 2011 closing yield on the U.S.10-year Treasury note at 3.75%.
Looking beyond 2011, it appears that the consensus further expects that the domestic economy is well on its way toward delivering a smooth and self-sustaining and normal historical recovery that (from start to finish) should last about four years. The clustering of that consensus suggests that any short- or intermediate-term variant outcomes could be destabilizing to the markets, both to the upside and to the downside.
To some degree, my surprises for 2011 attack some of the similar, non-variant and nearly universally optimistic expectations on the part of money managers, strategists, economists and members of the fourth estate. As such, I want to emphasize that my intention is 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 surprise list for 2011 recognizes 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.
More than almost any time I can remember, there exists few variant views relative to consensus as we enter the New Year. Perhaps leading that minority is Gluskin Sheff’s David Rosenberg, who, though thoughtful and thorough in analysis, is pigeonholed by the media as a dogmatic standard-bearer for the bear case. (Gluskin Sheff’s David Rosenberg succinctly underscores and questions the universal optimism in his commentary this week.)
“Those who cannot remember the past are condemned to repeat it.”
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.
Tags: Bettor, Black Swan, Blackstone, Brokerage Industry, Byron Wien, Casey Stengel, Chief Investment Strategist, Commodities, Consensus Expectations, Conventional Wisdom, Currency, Doug Kass, Eliot Spitzer, Emerging Markets, Gold, Hedge Funds, Improbable Events, India, Industry Consolidation, Mid 1990s, Morgan Stanley, New York Attorney General, Oil Sands, Payoffs, Playbook, Silver, York Attorney
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