Edward Harrison’s Ten Surprises for 2014, Update 1

It is about time I updated you on how the ten surprises for 2014 are faring. I actually have 14 but I only get credit on the first ten. The second ten are a bonus round. I am defining my surprises as events to which investors assign 1-in-3 odds of happening but which I believe have a more than 50 percent likelihood of occurring in 2014. If the list is mediocre, I should get 3 or 4 out of ten. If I guess right at 50% odds, I should get 5 of ten. Anything above 5 means I had a good year.

1. Brazil goes into a recession. Obviously it’s too early to know whether this pans out. But the data aren’t good, that’s for sure. And note that the central bank is raising interest rates because inflation is still too high. Real interest rates in Brazil are very high right now with inflation at 6% and the policy rate at 11%. This bet seems just as likely now as ever. And note that the IMF is saying corporate debt is too high in EM. This certainly affects Brazil.
2. Spanish GDP growth rebounds and outstrips German GDP growth. This is more of a bullish call on Spain than a bearish one on Germany. But the jury is still out on this one, even if Spanish 10-year yields are below US ones. The real economy is still not doing well. I think a basing effect will help as Spain is coming off a low base. But deflation will keep a lid on things due to debt deflation dynamics. Germany looks strong.
3. Gold rebounds to beyond $1600 an ounce. Gold was rallying as a safe haven due to emerging market turmoil. But it has gone back down to $1300. I don’t think gold goes higher unless we have an emerging markets crisis, especially with real yields in developed markets increasing as disinflation sets in. So this is really a play on EM and a flight to safety.
4. US GDP growth in Q2 and Q3 is below 2%. According to some recent numbers, US growth at the end of Q1 looked better than it did at the beginning. And that says the US economy may have momentum. I see 2% as a baseline. You go below 2% via an inventory purge or an exogenous shock. But if the end of Q1 trend holds, the US economy will do better than 2% in Q2 and Q3.
5. 10-year US Treasury yields fall below 2.25%. Treasury yields are holding tight in the 2.65-2.80% range. It’s not going to 2.25% without both the scenario in surprise 4 and an EM scare occurring. So, again this is a play on the now dormant EM crisis. Could events in Ukraine spark another round of panic? Maybe.
6. Abenomics ‘fails’ as Japanese GDP growth slips below 0.5%. It’s too early to call here. It is true that we are not getting any more easing. And given the consumption tax, that means the risk is high that Japanese GDP growth declines materially.
7. The US stock market falls as profit margins begin to decline. It’s again too early to call. If GDP growth accelerates somewhat, profit margins could remain high and that would underpin stocks.
8. US high yield spreads begin to rise. We are not seeing any signs of this. High yield is expensive. But what we are seeing is warning signs in leveraged credit that say froth is building and that individual bond selection will be important to not getting shellacked. It is entirely possible if the economy holds that this froth continues and builds even more.
9. Greece 2-year bonds rise gets access to market for bonds out to 5 years. Bingo. This is about to come true as the word on the street is that Greece is going to market with a 5-year deal tomorrow.
10. France underperforms as housing market cracks. France IS underperforming. And they are missing deficit targets. But the economy seems to have moved out of recession. Let’s see where this heads.

The 4 bonus picks were:

1. Canada’s housing boom stalls
2. China’s growth slows in at least two quarters to a 6% annualized rate
3. Australia’s housing market declines
4. Argentina defaults and takes pole position from Venezuela on inflation

I would say only bet number two is on track yet. Goldman is saying Q1 is going to 5% annualized growth. For the others, it is too early to call though.

As the year goes on, I will keep you updated on where these calls are headed and what it means about the macro picture.