Last year, I started my weekly subscriber newsletter out with Ten Surprises for 2012. The goal was to give Credit Writedowns Pro subscribers a list of things that investors only assigned one in three odds of occurring that I believed had a fifty percent or better chance of occurring. So if I was right, then I should get 5 out of ten predictions correct, while 3 to 4 out of ten should have been expected by investors. Let’s see how I did.
I have looked back to see how these predictions were faring during the year a couple of times. But I haven’t looked at them recently and as I write this I don’t know what my score is going to be. So I am keen to write this review and will write it on the fly as I see how each of the predictions pans out. I am putting this outside the paywall. My Ten Surprises for 2013 for subscribers will be coming soon behind the paywall.
Surprise #1: Greek investors finally take their writedowns: The latest from Europe is that policy makers believe even mentioning writedowns has created the crisis when in fact the crisis was going to occur anyway. The euro should never have existed because the euro zone doesn’t have an institutional framework to deal with economic crisis. Now the day of reckoning is at hand. And while the ECB has finally done what I told you they would and monetise sovereign debt, some directly and some via its three-year long term refinancing operation, this won’t be enough to stop the crisis without writedowns. So things will come to a head for Italy and that will force the Greek issue. That’s bearish for European bank stocks.
1-0: Surprise #1 was correct! The Greeks did finally give haircuts to investors in March. What else can I say here? In hindsight, this looks like an obvious call, but at the beginning of 2012 it wasn’t because everyone was saying that austerity would be enough and if it wasn’t then the Greeks might default down the line. My reasoning here was that the Europeans wanted to make Greece a special case in order to save the rest of the periphery, especially SPain and Italy from the contagion of what occurred in Greece. They were somewhat successful but eventually Spain and Italy were on the hot seat again as well.
Surprise #2: Romney will be elected President: when you look at one-term post World War II US presidents, usually an economic downturn killed them. The sixty Go-Go years were as much a problem for Johnson as Vietnam. Ford and Carter had stagflation and Bush 41 had the first jobless recovery. The Republicans can’t win if the economy holds. Obama has to hope 2012 will be good and I don’t think it will be good enough because he is unlikely to have won over many new voters through his policies but is likely to have lost some through low voter turnout apathy or defection because of his imperial-style anti-civil liberties approach. So this is about Obama and not about Romney. The Republicans cannot win with anyone else unless the economy tanks because the other Republican candidates are too far right of center and will drive up Democratic voter turnout and drive away moderates. Only Romney is moderate enough to win.
1-1: Surprise #2 was wrong! I knew this was one I got wrong. Why did I get it wrong, though? I believe it was because the economy held and Romney lurched too far to the right. Look at what I said last January: “The Republicans can’t win if the economy holds” and “the Republicans cannot win with anyone else unless the economy tanks because the other Republican candidates are too far right of center”. I think that’s right. But, the economy did hold and Romney joined the other Republicans on the right, losing people in the middle in the process. His famous 47% video comments were the nail in the coffin. Overall, the takeaway here is that the US economy has held up better than I thought it would, largely because Obama was able to prevent austerity from taking hold in 2012. That’s a big deal because it says, to me at least, that the US recovery has legs if the politics of austerity could be held at bay. But I believe austerity politics are worse now in the US than at any other time in recent memory.
Surprise #3: China will have a hard landing: I have a tough time on this one. But in keeping with the 50% odds when everyone else gives it one in three, I think China is the big story here. People who aren’t in the thrall of the China bull story know that the malinvestment there has reached breathtaking proportions. And with a second synchronised global growth slowdown in the last five years forming, China will get hit just as its over-investment bubble is popping. There are only so many losses it can socialise while its export and banking sectors are hit at the same time. The stimulus won’t be enough to prevent quarterly growth from stalling to say 5% annualised by the end of this year. That is China bearish given that stocks are already in a bear market. The additional real economy slowdown will hurt profits and sentiment, taking P/Es down with profits for a double whammy.
1-2: Surprise #3 was wrong! This one is a little tricky and I go back and forth because China doesn’t do quarterly growth rates and I didn’t specify a hard number for it as a result; China does annual growth rates. Anyway, most observers of China’s economy believe the numbers manufactured by the government are false. What we do know is that the official growth rate numbers were 7.8% for 2012 and that’s down from 9.2% in 2011. And so growth slowed to at least 7.8%, which is higher than the 5% bogey I used. Patrick Chovanec did some quarter-on-quarter estimates and got Q1 2012 at 6.6% annualised. But that was the trough. I see that one of my favorite sites, Trading Economics, has an estimate for quarterly growth up. Here’s what they say: “The Gross Domestic Product (GDP) in China expanded 2.20 percent in the third quarter of 2012 over the previous quarter. GDP Growth Rate in China is reported by the National Bureau of Statistics of China. Historically, from 2011 until 2012, China GDP Growth Rate averaged 2.1 Percent reaching an all time high of 2.5 Percent in June of 2011 and a record low of 1.5 Percent in March of 2012.”
So Trading Economics is saying that growth bottomed in Q1 at 1.5%, which is greater than 5% annualised. Moreover, growth rates increased as the year went on whereas I believed the growth rates would continue down as the year progressed before China reacted. The bottom line here for China is that the government reacted quickly and arrested the fall in growth so that (officially, at least) growth never dipped to 5% annualised. I know the 5% wasn’t a hard number. So I consider what happened in China a hard landing. The sub-50 manufacturing PMI prints tell you that. But, it was such a short episode that it wasn’t that hard for that long. So let’s call this one wrong, cognizant that the landing was more soft than hard because China is now growing again.
Surprise #4: India will be worse than China: Again, this is a tough one. Reports I hear from what’s happening on the ground in India are generally bullish in that people are telling me domestic consumer demand is still exploding higher. Yet, you have people like Christopher Wood cutting their forecasts from 7% to 6% growth. I think the cuts will be greater as the year unfolds. India has a balance of payments and currency problem that the other BRICs don’t. And like Brazil and China, the Indian Sensex was down big time in 2011. The only reason it rebounds is because of expanding multiples or expanding profits. yet India’s growth forecasts are being cut. So how do you get to expanding multiples or profits in that environment. You don’t?
2-2: Surprise #4 was correct! India has had a hard landing in contrast to China and the numbers are worse in India than they are in China. Here’s an article from Reuters saying that India’s GDP growth languishes, headed for a decade low. The economy in India grew only 5,3% year-on-year. That’s much worse than the lowest numbers in China. And the deficit there is growing. And inflation is still a problem, But let’s think about this in context; the GDP number is still higher than 5%. That’s miles a head of where we are in Europe and North America.
Surprise #5: Australia’s housing bubble will pop: I was just thinking about this in the context of Ireland. Ireland has seen prices in Dublin fall 65% peak to trough. That’s enormous, Japanese-style asset price deflation. No wonder Ireland is in a depression. In 2005, when the housing bubble was at peak, Irish house prices were up 192% in the previous 8 year period, second only to South Africa in developed economies surveyed by the Economist. By comparison, Australian house prices were up 114% putting them behind only South Africa, Ireland, Britain and Spain. I can’t speak to South Africa but those other bubbles have popped while house prices in Australia have climbed higher on the back of Chinese over-investment. if you think China will slow, as I do, that makes Australia extremely vulnerable – and makes its house prices and Australian shares vulnerable too.
3-2: Surprise #5 was correct: Just yesterday, I wrote a piece on how home sales are drying up in Australia. But apparently I was late to the party because Steve Keen points out that Australian house prices peaked in June 2010. That is over two years ago. They are down 10% in real terms since then. The key takeaway here though is that even though prices started a marginal decline in 2010, at the beginning of 2012 it was still possible to say that they would rise again and that the shallow decline would not be a factor. However, the economy in Australia is under-performing a great deal and the central bank has been forced to cut rates to record lows to keep things afloat. Given the fact that this has gone on for two and a half years now, it counts as a bubble bursting.
Surprise #6: European equities will outperform: you may have seen people like Jeffrey Gundlach saying that US-based investors want to stay with dollar based assets. What he was saying is that the euro is vulnerable to serious depreciation. I have been saying for a while that the ECB would backstop Italian (and Spanish) debt because the alternative is too grim. This is what’s happening now. That is euro-bearish in my view, just as Gundlach says. But if you avoid bank stocks, it can also be equity bullish. Barclays said last month that European Cyclically Adjusted P/E (CAPE) multiples are at their lowest since the 1980′s. And we know that there is a big multiple gap to the US from what Niels Jensen wrote in October. To me, that’s bullish – at least on a relative basis. Even if things come to a head in a negative way, why would you think European shares would decline more than US shares? For US investors, the risk is the currency. Europeans want to be overweight high quality, non-bank European shares.
4-2: Surprise #6 was correct! This prediction is a bit muddled because you can read what I wrote a number of different ways. I wish I had written it differently – or at least more precisely. As I said, I expected the euro to decline versus the dollar in 2012. It did, but only by about 2%. But, since I did write that, clearly I was talking about relative performance not including the currency translation. I should have said so. And more specifically, I was thinking about core European country stocks (Germany, Austria, the Netherlands and so on). But anyway, let’s look at the numbers. According to Bloomberg, the EURO STOXX 50 was up 18.19% in the year to today. Whereas the S&P 500 was up only 13.78% in the year to today. That means that the EUropean markets outperformed US markets despite the sovereign debt crisis, just as I had said. The takeaway here is that the multiple gap between Europe and the US is real and it means that relative value still exists in Europe even today.
Surprise #7: US real GDP growth is below 3% and while unemployment does drop, it rises again. This is just an anti-Wien prediction who said exactly the opposite. I’m not sure what his reasoning is for anticipating 3% US economic growth during a synchronised global growth slowdown but it doesn’t make any sense to me. Especially when he says oil is going to fall to $85 a barrel. I don’t see it.
5-2: Surprise #7 is correct! Clearly US growth is headed for a sub 3% year. As I wrote at the beginning of 2012, this one was mostly to counter Wien’s excessive bullishness. You don’t get oil down to $85 a barrel as Wien correctly predicted in the middle of a global growth slowdown without a hit to US GDP growth. And that’s what we saw. GDP growth was 2.0% in Q1, 1.3% in Q2 and 3.1% in Q4. Unless we get a monster Q4, which we wont, then you can be sure that GDP growth comes in below 3%. One note here though. I did mention that I expected unemployment to drop and then rise again. And this is true, that did happen. Unemployment started at 8.3%, dropped to 8.1% by April and rose back to 8.3% by July. But the second half of the year was robust, relatively speaking. Unemployment dropped to 7.8% from July to December. The takeaway here then is the same as it was for the Romney prediction: the second half of the year in the US was much better than I anticipated. That’s why Obama was re-elected.
Surprise #8: German GDP growth weakens significantly: As I have been saying for two years, I don’t see how you get a recession in Spain (or Italy) as well as elsewhere in the periphery and in France and Belgium now without Germany faltering. Remember, industrial production in Germany is already shrinking along with everybody else’s. And austerity will take a toll around the euro zone. How does Germany avoid this downturn. They don’t. In fact, you could make the argument that if recession goes global via a US slowdown, Germany would be more vulnerable to a wild downswing just like Japan because of its mercantilist economic paradigm.
6-2: Surprise #8 was correct! GDP for 2012 was a meagre 0.75%, much lower than in 2011 when it was 3.0%. While I just wrote this up earlier today, showing that industrial production in Germany probably contractedin Q4 2012, here are a few numbers. German GDP grew 4.2% in 2010. In 2011, it grew 3.0%. The official projection for 2012 as of October was for 0.8%. The actual number was a bit lower at 0.75%. And the projection for 2013 is now 1.0%. I expect the 2013 number to be revised down.
Surprise #9: Gold continues to lose its luster: gold wins when financial repression, defined as negative real interest rates, is the greatest. The higher the gap between inflation and long rates is, the higher gold will go because it goes from being a burden that has zero yield to being an asset that holds purchasing power amid government-sponsored wealth destruction. I think the inflation cycle has peaked. European inflation is coming down, Indian inflation and Chinese inflation are coming down. And policy rates, particularly in the US and Europe have no room to go much lower. That’s not gold bullish.
6-3: Surprise #9 was wrong! Okay, this is another one of these that was not well stated. You could argue that I meant the change in gold prices would be lower in 2012 than 2011. Thats what “The higher the gap between inflation and long rates is, the higher gold will go” implies. But I know I meant gold prices would fall. And while gold prices did fall through July, we saw a good rally until October that was enough, despite a fall through the end of the year, to make gold positive on the year. Here’s a one-year chart. So let’s call this one wrong.
Surprise #10: The ECB becomes more explicit about its backstops: As I write this, Italian interest rates are now edging over 7%. The question, especially when the Italians have to roll over so much debt, is how do they continue on in that environment? The answer is they can’t. If Italian yields stay at 7% for too long, everyone not just some bond investors will start to believe they are essentially bankrupt. That gets you into Greece territory. Bottom line: the ECB will then face a stark choice. Make their Italian backstop more explicit or go through a debt deflationary and depressionary crisis and cease to exist as an institution as the euro unwinds. I think they will choose inflation.
7-3! Surprise #10 was correct! The OMT program is the ECB’s explicit backstop. This was the big call for the year. No one was predicting this at the time as I remember it. At the time I made this call, it was Italy more than Spain that made me believe the ECB would grant an explicit backstop because Italy was the country in the hot seat. But you always have to view these two countries as a pair. Whatever happens to Italy will severely impact Spain and vice versa. I know their macro fundamentals and debt situations are very different. But it is the fact that they are both large economies that cannot be bailed out using the methods the Troika used for Portugal, Greece and Ireland that makes them similar. I believe we will see more action on this front in 2013. And I will be deciding what call to make specifically on this front in my surprises for 2013.
Anyway, that’s it. 7-3 is not bad. All in all, I am happy with how these predictions turned out – even the ones I got wrong – because the thinking behind them was solid. If I had to make a criticism, it would be that consistently economies tended to perform better than I thought they would – at least in China and the US. While I got Germany right, India was probably better than I said it was going to be. The takeaway for me is that, baring political wrangling creating problems as it is in Europe and the US, the underlying fundamentals are better than many believe.
I hope the list for 2013 comes out soon. I will be formulating it starting today. Stay tuned.