The Ten Surprises of 2019 worked out plenty well. While we don’t go through this process with the objective of getting a high score, knowing that you have been able to anticipate some of the generally unexpected events that are going to influence the financial markets during the coming year is gratifying. The real goal of the Surprises is to stretch our thinking and yours about high-impact investment events over the coming twelve months. The definition of a Surprise is an event which a professional investor would assign a one out of three probability of happening, but which we think is probable, meaning it has a better than 50% of taking place. Usually we get five or six pretty much on target, but last year we did better than that.
In looking back over 2019, the most positive factor was the accommodative monetary policy provided by the United States and other countries, which had a favorable impact on the economy and the financial markets. The most negative factor was the uncertainty created by the lack of resolution of Brexit in the United Kingdom and continued trade tensions between the U.S. and China, which drove down manufacturing activity and held up capital spending throughout the developed world. Even though both conflicts had positive developments in December, these issues are likely to persist next year.
In the first Surprise, we said the Federal Reserve, which had increased rates four times in 2018 (a Surprise we got right that year), would stop raising rates. They actually cut rates three times (a controversial move). Inflation remained subdued, as we suggested, and longer-term interest rates actually came down (we thought they would stay low but not drop as far as they did). The yield curve inverted briefly, but then turned positive, and has remained so through today.
For the second Surprise, we said that the Standard & Poor’s 500 would rise 15%. We thought we were showing our optimism by picking a number above the consensus, but we didn’t go far enough. At its peak, the index rose close to 30%. The fact that the Fed cut rates three times was an important contributor to the sharp appreciation. Ample liquidity fueled the move. Earnings did not improve significantly; rather, multiple expansion resulting from lower rates was the key factor in the market’s performance.
For the third Surprise, we said that capital spending and housing would be disappointing as economic drivers during the year. The economy would have to depend on the consumer and government spending. The consumer really came through, but government spending, which resulted in a near–trillion dollar deficit, was a factor as well. While many observers were concerned that the poor market performance during the fourth quarter of 2018 was a precursor to a recession in 2019 or 2020, we thought that the next recession would be in 2021 or later. We considered it unlikely that we would experience a serious downturn in an election year. The economic indicators we were looking at suggested that growth of about 2% would persist throughout 2019.
In the fourth Surprise, we thought 2019 would be a tough year for gold. Since we expected both the stock and bond markets to do well, we thought investors would turn away from gold, which had a cost to carry and no return. As a result of global political uncertainty and a cloudy economic outlook, gold had a good year along with the financial markets, and we got this one wrong.
In the fifth Surprise, we expected the emerging markets to perform well as a result of vigorous spending by the growing middle class in those countries. With the exception of China and Mexico, this didn’t happen as broadly as we anticipated, but the Shanghai Composite was up 25%, as we forecast, Brazil did well also in spite of the country’s problems. The Emerging Market Composite was up about 10% compared to more than 20% for the All Country World Index.
In the sixth Surprise, we thought the Brexit issue would remain unresolved in the United Kingdom. While we had hoped that there would be another referendum and a vote to remain, the December 12th vote determined that Britain will leave the European Union, though there is likely to be a prolonged transition process. This is unfortunate, because growth in the U.K. has slowed in anticipation of the separation. Hopefully, productive bilateral trade agreements will be worked out during the implementation period.
In the seventh Surprise, we expected the dollar to stabilize during the year because of the trade dispute with China. The dollar did strengthen versus the renminbi and rose slightly against the other major currencies, but there was not a major change. Foreign flows of capital into the United States did slow because of a softer economy, rising deficits, modest capital spending and high hedging costs.
In the eighth Surprise we said that the Mueller investigation into foreign involvement in the 2016 election would not implicate the president, but would be a problem for some of his family and close advisors. The report did not find a conspiracy between Russia and Trump or any of his people, but it also did not absolve the President of obstruction of justice charges. The impeachment trial in the Senate may go further than the Mueller report did in revealing troublesome information.
For the ninth Surprise, we said that Congress would get more done than expected during the year. With the impeachment process underway and a Democratic House of Representatives and Republican majority in the Senate, not much important legislation passed until December, when a trade arrangement was made with Mexico and Canada. Pressing issues like immigration and climate change continue to cry out for constructive action.
Finally, for the tenth Surprise, we said that growth stocks would continue to be market leaders. Growth stocks across market capitalization categories clearly outperformed the major indexes as a result of strong earnings. We expected energy stocks to do well as commodity prices rose, but these stocks were punished by investors, as energy companies found themselves unable to gain access to capital.
A number of people help in developing the list of Ten Surprises. Joe Zidle, now Blackstone’s Chief Investment Strategist, was a key part of the process; he will play an increasingly important role going forward. George Soros has helped with the Surprises for most of the 35 years of their existence and gave his views on markets and geopolitical issues. The Third Thursday Group of former Wall Street research directors provided their thoughts, during an always turbulent sushi and champagne lunch we enjoy every December. Gideon Rose and Dan Kurtz-Phelan of Foreign Affairs at the Council on Foreign Relations discussed their insights. Friends and Blackstone folks provoke us with their ideas. In the end, as always, we take responsibility for the Surprises and are personally accountable. Now on to 2020. We will discuss them in detail in the February essay.
Byron and Joe's Ten Surprises for 2020 are as follows:
1. The economy disappoints the consensus forecast, but a recession is avoided. Federal Reserve Chair Powell lowers the Fed funds rate to 1%. Without a comprehensive trade deal in hand, President Trump exercises every executive authority he has to stimulate growth and ward off recession. He cuts payroll taxes to put more money in the hands of consumers.
2. Inequality and climate change become important election themes, but centrist ideas prevail. The House of Representatives sends articles of impeachment to the Senate, but Donald Trump is not convicted or removed from office. Enough information is revealed in the proceedings to cause some of his supporters, as well as many independents, to throw their support to liberal candidates in 2020 state races. The Democrats take the Senate in November.
3. There is no comprehensive Phase Two trade deal that limits China’s ability to acquire intellectual property. National interests result in the balkanization of technology. The development of separate standards for 5G and other tech hardware proves to be bad news for the future of world economies. The move toward “decoupling” gains traction in negotiations with China. US economic co-dependence with China erodes. Both China and the US keep their hands off Hong Kong and let the protest settle down by itself.
4. The prospect of a self-driving car is pushed further into the future. A series of accidents with experimental vehicles causes a major manufacturer or technology company to issue a statement that it is no longer developing self-driving technology.
5. Emboldened by the pain of economic sanctions, Iran takes advantage of America’s unwillingness to intervene and steps up acts of hostility against Israel and Saudi Arabia. The Strait of Hormuz is closed and the price of oil (West Texas Intermediate) soars to over $70/barrel.
6. Even though some observers believe valuations are stretched, a surge in investor enthusiasm pushes the Standard & Poor’s 500 above 3500 at some point during the year. Earnings increase only 5%, and S&P 500 multiples remain elevated because monetary policy is easy and investors become more comfortable that intermediate interest rates will rise slowly. Volatility increases and there are several market corrections greater than 5% throughout the year.
7. Big tech companies face growing political scrutiny and social blowback. Once the market leaders, certain FAANG stocks underperform and the equal-weighted S&P 500 outperforms. A proposal to break up the largest social media platforms and increase regulation and government oversight gains popularity. This has greater success than prior government efforts against Apple, Microsoft and IBM, because it has widespread support from the American people. A millennial in New York City puts a phone down and makes eye contact with another human and finds it non-threatening and refreshing.
8. Having secured a workable Brexit deal, the United Kingdom turns out to be the winner in its divorce from the European Union. The equity market rises and the pound rallies. The UK benefits from a long transition period, and growth exceeds 2% as foreign direct investment resumes now that the outlook is clarified. The EU economy remains soft, and European markets other than the UK underperform the US and Asia.
9. The bond bubble starts to leak, but negative rates continue abroad. Even though the US economy is slowing, the 10-year Treasury yield approaches 2.5% and the yield curve steepens. Japan and China pull away from the Treasury auctions. Rather than economic fundamentals or inflation, supply and demand drive yields higher.
10. The problems with Boeing’s 737 Max are fixed and deliveries begin. The plane becomes a mainstay around the world, enabling airlines to operate more efficiently and increase profits. The stocks become market leaders.
Every year there are always a few Surprises that do not make the Ten, because we either do not think they are as relevant as those on the basic list or we are not comfortable with the idea that they are “probable.”
11. Fears of an economic crisis in India are allayed. The emerging markets continue to have uneven performance but India recovers from decelerating growth. The Modi government continues business-friendly growth reforms, the economy grows at 6% and the market rises 20%.
12. Artificial intelligence begins to be viewed as a paper tiger. The AI jobs apocalypse fails to materialize, much as the Y2K bug failed to undermine the US economy 20 years earlier. Manufacturing jobs have already been automated and it proves harder to eliminate service jobs by using computer-based applications.
13. Economic problems in Russia intensify even though the price of oil rises. As a result, social unrest begins to spread. Putin’s cozy relationship with his circle of oligarchs becomes an issue and his influence as a world leader diminishes. He attempts to maintain his stature on the world stage through a closer association with China. In spite of serious differences, China and Russia appear prepared to face off against Europe and the United States.
14. Populism and inward-thinking continue to spread globally, particularly in emerging markets. Anarchy and disharmony spread throughout the world, creating turbulence in financial markets everywhere. Investors turn away from emerging market local currency debt, forcing spreads higher.
15. North Korea agrees to suspend its nuclear development program after another meeting with President Trump, but does not give up its existing stockpile. Kim Jong-un halts work on a long-range missile capable of reaching the United States. North Korea continues to be a threat, but not an imminent danger.
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The views expressed in this commentary are the personal views of Byron Wien and Joe Zidle and do not necessarily reflect the views of The Blackstone Group Inc. (together with its affiliates, “Blackstone”). The views expressed reflect the current views of Byron Wien and Joe Zidle as of the date hereof, and none of Byron Wein, Joe Zidle or Blackstone undertake any responsibility to advise you of any changes in the views expressed herein.
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