Edward Harrison’s Ten Surprises for 2014, Update 2
Today is the time to update you on how my 2014 surprises are faring and why. Just to remind you, the surprise list is based on Byron Wien’s list of ten surprises which he has been conducting for the last thirty years. Surprises are events to which investors assign 1-in-3 odds of happening but which I believe have a more than 50 percent likelihood of occurring. 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.
Here is my list:
- Brazil goes into a recession
- Spanish GDP growth rebounds and outstrips German GDP growth
- Gold rebounds to beyond $1600 an ounce
- US GDP growth in Q2 and Q3 is below 2%
- 10-year US Treasury yields fall below 2.25%
- Abenomics ‘fails’ as Japanese GDP growth slips below 0.5%
- The US stock market falls as profit margins begin to decline
- US high yield spreads begin to rise
- Greece 2-year bonds rise gets access to market for bonds out to 5 years
- France underperforms as housing market cracks
Plus for kicks but not counted are:
- Canada’s housing boom stalls
- China’s growth slows in at least two quarters to a 6% annualized rate
- Australia’s housing market declines
- Argentina defaults and takes pole position from Venezuela on inflation
Let’s analyze these in order.
Brazil. If you look at Brazil’s growth rate, it did lob in a negative print in Q3 2013. But 2014 has been a tad better at +0.2% in Q1. That could be the low here. With the emerging markets crisis having eased and Brazil getting a stimulus due to the presidential elections, I think this one is going to be a miss. Government spending is up 11% year-on-year. But we do have three more quarters’ data to watch and consumer and business confidence has been falling. For example, in July consumer confidence reached the lowest level since 2005. In Brazil, it’s touch and go.
Spain. I touched on the Spain vs. Germany theme yesterday. And it looks good so far. Spain has grown by 0.4 and 0.6% in Q1 and Q2 respectively whereas Germany had a monster 0.7% print in Q1 followed by a 0.2% fall in Q2. I see Spain better positioned to grow here and I really do think this is an outlier that no one expected when I made the list in February. Spain is actually exceeding government estimates which are getting raised. And Germany is below estimates which are getting cut.
Gold. Gold at $1600 is never going to happen this year. $1600 was always going to be a hugely aggressive target, probably less than a 1 in 3 chance. Still it won’t happen. The need for a gold safe haven has dissipated as the EM crisis has gone away.
US growth below 2%. OK, this prediction was totally mis-timed. My analysis was spot on but the growth drop came in Q1 already and not Q2 and Q3. I said at the time, “All evidence that a credit acceleration is coming has petered out… At the same time, wage and income growth is only enough to sustain up to 2% growth. So my prediction here is that 2% growth is all we should believe we are going to get. Below 2% growth would be a surprise.” Spot on but mis-timed. Q2 was an acceleration, not just catch up. Production and inventories will make Q3 pretty good as well.
10-year US Treasury yields fall below 2.25%. We are getting there. And here’s the interesting bit. I was saying the low yields would be a reflection of economic weakness. Yet, only recently have we plumbed the yield depths on the 10-year. That tells you that despite the acceleration in Q2 the underlying economy is still weak. This is not just a safe asset bid. There is an economic component there. And I think it could still get us to 2.25%.
Abenomics ‘fails’ as Japanese GDP growth slips below 0.5%. Maybe this one was easy and not really a one in three pick because Q2 came in at –1.7% and everyone should have seen this coming. But the key here is that the moving average GDP growth rate is now below 0.5% and that’s totally unexpected given how well Abenomics was gong before. More sales tax hikes are coming, despite poor wage growth. I am not bullish on Japan.
The US stock market falls. Wrong… so far. I am actually more interested in the reasoning here as I said the fall would be due to profit mean reversion. And profits have gone the other way. Corporate margins are at record levels. Here’s something that’s interesting though. Retail profit is down: Macy’s, Walmart, Fedex. They have all cut 2014 estimates or warned. And corporate America is being buoyed buy share repurchases, according to Jim Chanos. I think the reasoning here is spot on. The market is more vulnerable today than it was in February.
US high yield spreads begin to rise. This has already happened. So I got this one right. Even so, junk spreads have come in again. So, going forward, I think the question is how the credit cycle proceeds. With retail starting to buckle, it suggests that consumers are reaching their maximum without wage growth. And overleveraged high yield companies will start feeling pressure unless we see a pickup in wages soon. I think high yield is the canary in the coalmine for further recovery or slide into recession.
Greece 2-year bonds rise gets access to market for bonds out to 5 years. This has happened. And Greece was recently upgraded two notches by Moody’s. So people are bullish here. The question now is whether it is sustainable. I don’t think it is. Greece’s debt levels are too high to be maintained without an ECB backstop. And if you look at the short end of the curve, Greece is much wider than the rest of the periphery. Greece last sold 3-month paper at 1.75% and that debt is trading at 2.00%. Portuguese 6-month paper is at 0.157% and Spanish is at 0.103%. That tells you that there is still a lot of default risk embedded in Greek debt because short dated government bonds should provide the least risk.
France underperforms. Yes. France is the sick man of Europe right now. In February I said, “The EC is saying the economy will grow 1% this year. I don’t see it. Morgan Stanley has France at 0.4% growth. That sounds like a more legitimate number. Even so, the EC says that France’s budget deficit will increase to 4% this year. That will be a political problem. My call here is that France will do worse than anticipated i.e. growth will be lower than 1.0% for the rest of the year. Q2 and Q3 growth will come in much less than that. Recession is an outside possibility.” That’s spot on. It’s not clear how much the housing situation is adding to French problems though. France is now joined by Italy as a weak link in Europe.
So that’s the list. I think I have a reasonable shot at getting 5 or 6 of these right by year’s end. On the supplementary list: Canada’s housing boom stalls – NO. China’s growth slows in at least two quarters to a 6% annualized rate – again, NO. The stimulus has come online after just one quarter of sub par growth. I will have to see if we had 6% annualized growth in Q2. I don’t think we did. Australia’s housing market declines – NO, Chinese demand has helped keep things afloat. And Argentina defaults and takes pole position from Venezuela on inflation – YES. Expect more problems in Argentina economically.