15 Surprises Headed Our Way in 2016

“I begin every day by asking three important questions. One among them is this: ‘In a paperless and “cloudy” world, are we as investors and citizens as safe as the markets assume?

I’ve posed this question in my diary on at least 10 occasions in the past year, as it’s been a frequent concern of mine. On Friday in Paris, we were reminded again that we live in an open society and, as such, we are exposed to ISIS jihadists. … As I have pointed out many times, I have feared the exposure of our free society to acts of terrorism for some time. As citizens and as investors, we are simply not as safe as the markets assume us to be.”

 

— Doug’s Daily Diary, The Constant Risk of Terror (Nov. 14, 2015)

My overriding theme and the central drama for the coming year is that unexpected events can take on greater importance as the Federal Reserve ends its near-decade-long Zero Interest Rate Policy.

Consensus premises and forecasts will likely fall flat, in a rather spectacular manner. The low-conviction and directionless market that we saw in 2015 could become a no-conviction and very-much-directed market (i.e. one that’s directed lower) in 2016.

There will be no peace on earth in 2016, and our markets could lose a cushion of protection as valuations contract. (Just as “malinvestment” represented a key theme this year, I expect a compression of price-to-earnings ratios to serve as a big market driver in 2016.)

In other words, I don’t think 2016 will be fun. I think few investors (and that includes Warren Buffett) will be Tap Dancing to Work. In fact, I think investing will prove unprofitable for many — more so than in any year since 2008.

Once again, I’m taking on a decidedly negative tone — suitable to in my old early 1990s role as “The Bear of Boca.” I’m basing my bearishness on a backdrop of continued heinous acts of terrorism, economic and profit disappointment and the general gloom and doom that’s immersing our citizens and our markets.

Risk will happen fast over the next 12 months, and “T.I.N.A.” — the view over recent years that “there is no alternative” to stocks — will prove to be just another spurious justification to be bullish in stocks. In its place, I think cash will be anointed as 2016’s new king.

While some might accuse me of being apocalyptic, I contend that I’m simply raising the flag of common sense in a most uncertain world.

But again, it’s important to note that my surprises aren’t intended to be predictions, but rather events that have a reasonable chance of occurring. I call these “possible improbable events.”

And again, the purpose of putting together this list is to help you position a portion of your portfolio in accordance with outlier events, with the potential for large payoffs on small wagers/investments.

With that said, here are my 15 Surprises for 2016:

Surprise No. 1: Terrorism Dismantles an Already Fragile Global Recovery
I fear we’ll see attacks that demonstrate how terrorism incidents are systemic and not (as the consensus sometimes believes) simply isolated. It could become apparent that we face a broad, aggressive wave of terrorism aimed (as expressed by ISIS) at defeating the West’s world domination.

Acceptance of this notion would cause significant disruption in global markets and the world’s economies. Shares in airlines, hotels, entertainment companies (especially theme-park related) might suffer the most throughout the year.

Surprise No. 2: Terrorism Goes Cyber
Middle Eastern, Russian and Chinese hackers successfully invade the U.S. financial system’s computers at various points throughout 2016. They consistently launch destabilizing attacks against multiple trading platforms (the New York Stock Exchange, the Chicago Mercantile Exchange etc.) and the overnight electronic settlement system.

This causes a series of temporary multi-day trading halts, shattering confidence in our markets.

Surprise No. 3: ‘The Mother of All Flash Crashes’
One of these cyber-attacks causes “The Mother of All Flash Crashes,” which scares  the hell out of many market participants. The Dow Jones Industrial Average falls by 1,100 points — the largest one-day point decline in history.

Almost immediately following a Democratic presidential win in November, President-Elect Hillary Clinton attacks the market-rigging, unholy alliance between high-frequency traders the stock exchanges. A special congressional commission is formed after the flash crash to address the HFT industry and its fellow travelers.

In an attempt to correct the unfair playing field that’s evolved, the government declares co-located servers illegal and bans “spoofing” and other dirty work that’s become routine in the HFT industry. The market’s fragmentation and illusion of depth that have allowed quants to profit at the expense of other investors reverses as new, punitive and costly regulations threaten Wall Street’s “dark pools.”

However, legislation from Sen. Elizabeth Warren (D-Mass.) to revert both the Nasdaq and New York Stock Exchange back to non-profit status fails to make any progress.

Surprise No. 4: Terrorism Hits Mideast Oil Infrastructure
The Islamic State destroys a significant amount of Mideast oil-producing countries’ infrastructure. This occurs at the same time more violence erupts in the Niger Delta, Algeria suffers from political chaos and a coup disrupts Venezuela’s oil production.

While outsized oil inventories initially stem energy-price increases, crude rises above $60 a barrel in 2016 — sparking, among other issues, fears of reflation. (Energy stocks continue to falter at first, then soar in response to the Mideast hostilities.)

Surprise No. 5: America Falls into Recession and Stocks Tank
Too much debt, too little growth, fiscal-policy paralysis, a “spent” Federal Reserve and limited capital spending (which adversely impacts productivity) weigh down stocks in 2016. So do crony capitalism, geopolitical instability a further narrowing of market leadership and a further technical breakdown.

The current U.S. expansion is now more than 70 months old, one of the longest in history. There have been six recessions since 1971, and the S&P 500’s average drop during them is 36%. I predict 2016 will see the seventh recession in the last 45 years, with stocks experiencing a 20% decline.

“You may like them (stocks).
You will see.
You may like them,
but not for me.”
— Doug’s Daily Diary, Green Eggs and Stocks: Neither Rocks (Dec. 17, 2015)

Few asset classes will be spared, and household net worths will suffer. Rising bond prices had the effect of somewhat buffering falling stock and home prices in the last downturn. But we won’t be so fortunate this time as stocks, real estate and bond prices will likely all decline at the same time.

Other key economic/market features of the year:

  • U.S. real GDP suffers two back-to-back declines in 2016’s third and fourth quarters. Corporate profits turn negative in the second quarter as the largest number of earnings guidedowns since the Great Decession develops.
  • Profit margins drop precipitously as revenues come in well below expectations and costs rise ever higher.
  • Productivity will decline in the face of the past few years’ limited capital expenditures.
  • S&P 500 stocks’ 2016 earnings per share will come in under $100 (dropping off dramatically in the second half). That’s more than 15% below today’s consensus expectations.
  • Price-to-earnings multiples contract.
  • Share buybacks are 50% lower in 2016 vs 2015.
  • Merger-and-acquisition activity slows to a crawl.
  • 2016 produces the lowest number of IPOs in eight years.
  • The U.S. dollar’s bull run ends. Our currency fails to appreciate as the consensus expects. Instead, it slumps in response to terrorism within our borders and to cyberattacks directed at our financial system.
  • Oil temporarily exceeds $60 a barrel.
  • The U.S. housing market suffers in price and sales volume.
  • Auto industry sales (SAAR) decline by over 2 million units to under 15 million.
  • Another peak is seen in 2016: “Peak Employment.”
  • Despite weakening economic growth, the 10-year Treasury’s yield spikes to 3% on inflation scares.
  • The VIX breaches 40 to the upside during the year.

Surprise No. 6: Stagflation
I think stagflation could join “screwflation” as a concern for 2016. Wages could rise and non-energy commodities (particularly agricultural) could pass the Federal Reserve’s inflation target despite disappointing U.S. growth.

Although we could see slowing and recession-like growth in 2016’s third and fourth quarters, the yield curve won’t invert. But oil and a drought that causes higher agricultural prices could raise headline inflation to well above the Fed’s target.

Surprise No. 7: The Fed Doesn’t Raise Rates
Low U.S. nominal GDP growth (under 3%) didn’t stop the Fed from raising rates earlier this month, even though the indicator was close to 7% the last time the central bank initiated a rate-hike cycle in 2004. And prior to the 2004 cycle, the Fed raised rates at a time when nominal GDP growth ranged from 5% to 7%.

However, I think 2015’s rate hike will prove to be a policy error. Despite the consensus of two to three more hikes in 2016 (and the Fed’s own forecast of four increases), I predict the Fed won’t raise rates at all in 2016. Chairman Janet Yellen will be roundly criticized for failing to raise interest rates before 2015, and confidence in the Fed will begin to mirror the low readings previously reserved for Congress.

Confidence will deteriorate ever further as America falls into recession. An attempt by several senators to replace Yellen will falls short for procedural reasons, but pressure will remain on her throughout the year and into 2017.

Surprise No. 8: China and Russia’s Economies Falter
China’s real GDP growth rate (at least as stated) could fall below 5%. Unemployment rises and riots ensue, forcing the government to clamp down on social media.

As a form of distraction (and an attempt to expand its political and economic reach), China flexes its military muscle and gets more aggressive in the South China Sea. A hot-headed ship captain causes a crisis and President Obama considers sending U.S. ships into the disputed waters.

Despite a rise in oil prices, Russia’s economy implodes. Russian leader Vladimir Putin grows increasingly irrational and retaliatory towards his perceived enemies, precipitating more confrontations and crises.

Surprise No. 9: The European Union Begins to Unravel
German Chancellor Angela Merkel’s open-door immigration policy backfires and causes her to resign, while Britain leaves the EU (a “Brexit”) under the assault of Euro-skepticism.

Separatist initiatives in Scotland and other countries advance and France’s National Front party rises to new heights in the face of immigration fears. Support to Greece and other EU peripheral countries diminishes, causing another emerging-market crisis. European borders are shuttered and trade comes to a halt.

Surprise No. 10: It’s Hillary vs. The Donald
The U.S. far left and far right both surge in popularity as voters lose faith in the political status quo. Despite his rude and crude campaign, a series of terrorist acts within U.S. borders propels Donald Trump ahead of all of his Republican competitors.

The “bromance” between Trump and rival GOP presidential candidate Sen. Ted Cruz continues, and The Donald makes the Texas senator his running mate. Clinton selects former San Antonio mayor (and current Housing Secretary) Julian Castro as her running mate.

The first Clinton/Trump presidential debate attracts nearly 100 million viewers. Given the world’s chaotic landscape, the November election is much closer than expected, but Clinton beats Trump 293 electoral votes to 245.

As her first initiative (even before her January inauguration), President-elect Clinton adopts a populist crusade that immediately attacks income and wealth inequality by recommending a large “wealth tax” and an increase in the U.S. minimum wage.

Clinton generally snubs the Republican Party and fills her cabinet with some of these individuals: Bernie Sanders (Veterans Affairs), Roger Altman (Treasury), Cory Booker (Housing and Urban Development), Joseph Sestak (Defense), Howard Dean (Health and Human Services), Wesley Clark (Homeland Security), Jennifer Granholm (Commerce) and Kamala Devi Harris (Justice).

Surprise No. 11: Housing and Autos Tank
The housing and auto industries are exposed as Potemkin Villages on weak foundations. Home prices drop by over 5% as affordability gets stretched, mortgage rates climb and unemployment rates bottom out.

As for cars, rising interest rates, the fear of sooner-than-expected smart mobility and autonomous vehicles (coupled with a sharp drop in SAAR) pummels Ford (F) andGeneral Motors (GM). Fierce competition appears from Alphabet (GOOG, GOOGL),Tesla (TSLA) and Apple (AAPL) for a share of the emerging mobility market. Add in a spike in auto-loan delinquencies and autos become one of 2016’s worst-performing sectors.

General Motors “tax inverts” in response to dour sales and the lack of corporate tax reform. It merges with European-based Rolls Royce Holdings (RYCEY).

Surprise No. 12: Warren Buffett Stumbles (Literally and Figuratively)
The Oracle of Omaha’s core investments — Coca-Cola (KO), IBM (IBM), Wal-Mart(WMT), Deere (DE), American Express (AXP) and Wells Fargo (WFC) — continue to falter as their protective “moats” dry up.

Investors become further concerned when Buffett falls and breaks a hip, causing him to be away from Berkshire Hathaway (BRK.A, BRK.B) for several months. As result (and in the wake of move lower in Berkshire’s share price to below book value), Buffett is forced to announce the name of his successor, who begins to pick up some of the Oracle’s responsibilities in 2016.

Surprise No. 13: Goodbye FANG and NOSH, Hello CRABBY
TFANG and NOSH — Nike (NKE), O’Reilly Automotive (ORLY), Starbucks (SBUX) andHome Depot (HD) — fall back to Earth and join the market’s soldiers.

TFANG and NOSH’s market leadership is replaced by a new market leader: CRABBY. That’s Citigroup, (C), Radian (R), Allstate (ALL), Bank of America (BAC), theBlackstone Strategic Credit closed-end fund (BGB) and Allegheny Corp. (Y).

Surprise No. 14: More Unicorns
Expect more private-equity unicorn dropouts in 2016 than you’d find truants in Animal House’s Delta fraternity.

Excessive valuations will again remind Silicon Valley that “fat, drunk and stupid is no way to go through life, son.” Cue the music.

Surprise No. 15: Individual Situations
Here are some individual stock, market sector and other surprises for 2016:

  • Apple makes a $20 billion+ acquisition and the shares trade at $90 after two consecutive, large earnings misses.
  • JPMorgan Chase (JPM) and Morgan Stanley (MS) merge.
  • Goldman Sachs (GS) significantly bolsters its money management operations by acquiring T. Rowe Price (TROW).
  • Two private-equity firms compete to acquire retailer Macy’s (M).
  • Web entrepreneur David Rosenblatt replaces Marissa Mayer as CEO of Yahoo(YHOO).
  • After three years of overpromising and underdelivering, Douglas Oberhelman resigns as CEO of Caterpillar (CAT).
  • Stung by large losses in Chesapeake Energy (CHK) , Cheniere Energy (LNG),Freeport McMoRan (FCX) and other companies, Carl Icahn steps down and appoints his son Brett as CEO of Icahn Enterprises (IEP). Icahn also meaningfully reduces his investment in Apple in 2016.
  • Rigid drone legislation and the institution of an Internet commerce sales tax stall the share price advance at Amazon (AMZN). Instead, the stock falls by over 30%.
  • Despite a weakening economy (and against conventional wisdom), the high-yield bond sector is among 2016’s top-performing asset classes The spread-widening we saw in 2015’s second half ends in 2016’s first six months, in part because a sharp oil-price spike results in a brilliant recovery by energy-related junk bonds.
  • 2016’s best market sectors: Defense, banks and fertilizers. Defense stocks — i.e.,Lockheed Martin (LMT), Boeing (BA) and Raytheon (RTN) — soar as terrorism at home and abroad causes a broad response and military initiatives. Bank stocks benefit from a cessation of legal-and-compliance costs and an upward-sloping yield curve, but a second-half U.S. recession cuts into first-half gains. Fertilizer stocks rebound mightily after droughts hit around the world.
  • 2016’s worst market sectors: Media, transports (particularly airlines and autos), electrical utilities, pharma/biotech and REITs. Terrorism, an accelerated pace of “cord cutting” and lower U.S. economic activity are a toxic cocktail for Comcast (CMCSA),Delta Air Lines (DAL), Starbucks, Nike and Walt Disney Co. (DIS). (ESPN subs drop below 80 million by year’s end.) Prices for theme parks, coffee and sneakers all fall as demand elasticity finally surfaces during the incipient recession that occurs in the year’s second half. A rapid drop and improved solar technology pose a competitive threat to electric utilities, while the Clinton administration comes down hard on drug prices. Finally, on REITs — see the next bullet point!
  • Mall sales traffic collapses. Several mall-based REITs perform the way of master limited partnerships did in 2015. Dividends get slashed in the face of a slowing economy, rising oil prices and the continued Internet inroads that are rapidly changing consumer behavior.
  • Sears (SHLD) finally succumbs to a weaker domestic economy and a deteriorating shopping experience at its stores and goes bankrupt. Icahn accumulates Sears bonds and takes control of the company out of bankruptcy.
  • The aforementioned issues (the devastation of malls and a Sears bankruptcy) precipitate a U.S. non-residential real estate crisis.
  • High-end real estate prices in New York City, the Hamptons and Los Angeles fall 15%. National home prices drop by 5%.
  • Water grows more scarce and a new, powerful “Silicon Valley Northwest” emerges. The Bill and Melinda Gates Foundation IPOs a home-grown company that develops a breakthrough technology that inexpensively turns wastewater and sewage into potable water. (Bill Gates contributes his entire stake in the company to charity.)  Later in the year, the Gates Foundation announces additional important innovations in health care, medicine and nutrition.
  • Sovereign-wealth funds (which are currently about twice the size of the hedge-fund industry) exit the markets and redeem from hedge funds, exacerbating the market’s slide.
  • Hedge funds experience record redemptions and outflows as investors get impatient with high fees and poor investment performance.
  • Several legendary hedge hoggers (each with funds holding assets under management over $5 billion) close shop. The pressure is particularly intense on activist investors who find themselves with large and concentrated holdings. As in Hotel California, “you can check out any time you like, but you can never leave” (without large losses). A few of these former Wall Street titans retire to a new high-end subdivision at Del Boca Vista in South Florida.
  • There are big changes in the business media. CNBC’s Joe Kernen joins Maria Bartiromo as an anchor at Fox Business Network. Andrew Ross Sorkin’s Showtime series Billions captures seven Emmy nominations, so he departs both CNBC and The New York Times for MSNBC as host of the new Sorkin Report. Carl Quintanilla joins NBC’s The Today Show. Seema Mody and David Faber (in a returning role!) replace Joe and Andrew on CNBC’s Squawk Box. Kelly Evans leaves CNBC and joins Bloomberg in a dual role, with Tom Keene as a co-anchor of Market Surveillance and as anchor in a new 4 p.m. segment.

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About the Author: Tyler Durden

2 Comments

  1. Interesting predictions. A few nitpicks – Vladmir Putin is one of the most shrewd world leaders and I suspect he has something up his sleeve that isn’t oil. The other one is that the Republicans will not allow The Donald to get nominated and like they usually do, nominate a loser.

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