Byron Wien: A Positive Look Ahead
This is the 36th year of The Ten Surprises. Joe Zidle, Taylor Becker and I have worked on them over a period of several months. I am frequently asked if the process were harder this year than in years past because of the impacts of Covid. The answer is that it always seems difficult. Every year, the process begins in the summer to determine the consensus views and ends around Christmas as we continue to fine-tune ideas that fall within our definition of a Surprise: an event that the Strategy team believes has a better than 50% probability of taking place, but that the average professional investor would only assign a one-out-of-three chance of occurring. To be a Surprise, the circumstance must be contrary to the consensus or more extreme—higher or lower—than the consensus.
The tragic events in Washington on January 6th, two days after the Surprises came out, will linger with us for some time. The first Surprise was whimsical and seemed appropriate, assuming Donald Trump were to leave office quietly. The same is true for the third Also Ran. With the storming of the Capitol, humor seems out of place now, but past practice has been to not alter the form of The Surprises as originally presented.
The first Surprise is that we have not heard the last of Donald Trump. Feeling deprived of a second term, he forms, or attaches himself, to a cable network and stars in the lead program, The Chief. In the weekly show, he interviews heads of state and CEOs with management styles like his own. His interview of Vladimir Putin draws more viewers than any cable program in history. He also plans his 2024 presidential campaign. While perhaps doubtful that this will happen exactly as described (you can say that again!), we wanted to start out this year showing that we don’t take ourselves too seriously. We know as well as everyone else that nobody can predict the future with any accuracy. The Surprises are a serious attempt to speculate on what unexpected events might occur in the year. If 2020 taught us anything, it is that unexpected developments can overturn everything and have the biggest impact on the world and on portfolios. We are already seeing the same play out in 2021. That’s why thinking about those events that the markets aren’t considering or pricing in is valuable.
In the second Surprise, we said that President Biden would try to restore an effective trade and diplomatic relationship with China. We view the hostile rhetoric from both sides during the presidential campaign as unproductive. The United States and China are the first and second largest economies in the world, and a more cooperative relationship between the two would benefit everyone. During the past two years, China has gained in relative competitive strength. While the Covid epidemic began there, China’s control of the virus has been quick and effective, and it was the only major industrialized country to have positive real GDP growth in 2020. This has strengthened the government’s resolve, as shown by harsh measures implemented in Hong Kong, over the past year. China has gained the respect of many nations abroad as certain weaknesses in liberal democracies in the West have been revealed. As a result, China may not feel it needs a workable relationship with the United States at this time. In addition, there is strong bipartisan consensus in Washington for a tougher orientation towards China. For these reasons, the achievement of a détente or strengthening of relations would be both surprising and a major development for the first term of the Biden administration.
We were optimistic in Surprise Three, thinking that the US would return to some form of normal by Memorial Day at the end of May. Most observers expect normalcy to occur in the second half of the year, so this one is in the direction of the consensus, but more aggressive. We anticipate that worldwide between five and ten vaccines will be available. The big challenge will be distributing them and getting people to take them. Preliminary polls show only somewhat more than half of American adults plan to take the vaccine. Based on the experts we’ve consulted, 70% of the population would need to be vaccinated, with a 90% effectiveness rate, to achieve herd immunity. Getting there in the first half of the year will take some persuasive effort. Some observers have revised their views of what it will take to reach herd immunity, thinking as many as 80% or 90% of the population may need to get the vaccine for people to meet in groups without becoming infected. Even the respected Dr. Anthony Fauci has moved his estimate into that range, so “normal” may occur later than originally hoped for, but we maintain a date of Memorial Day in our Surprise. Those completing the procedure will need to show proof of vaccination in order to be granted admission to theaters, movies, restaurants, sporting events and air transportation. The Summer Olympics, postponed from last year, will be held in 2021 with spectators.
In Surprise Four, we speculated that the Justice Department would become meaningfully less aggressive in its case against the major technology companies like Google and Facebook. The government’s case rests on the view that the acquisition practices of these companies stifle competition. There is also a set of cases alleging anti-competitive price fixing for advertising involving Facebook and Google. The public voices concern that its personal data is compromised. Almost everyone agrees that the internet and these companies have improved the quality of life over the past 20 years and the polling data shows it, so the zeal to break them up has subsided somewhat. Nonetheless, the government seems determined to move forward, so any pullback would be a Surprise.
We were optimistic about the outlook for the economy in the fifth Surprise. There is clear evidence of increasing demand for services, as a wide segment of the population yearns to get out of the house and return to an active lifestyle. Fiscal and monetary policy remain accommodative, so hospitality and airline stocks should perform well in the recovery. Nominal GDP exceeds 6% and unemployment drops to 5%. It looks like we have begun an economic cycle that is likely to exceed the decade-long cycle that ended with the beginning of the pandemic. While employment is only halfway back to where we were last February, income has recovered three-fourths of the lost ground. The bottom fifth of the workforce has suffered the most with severe job losses and reduced income. As we return to normal after vaccines become available, we expect restaurants will open, theaters and sports stadiums will operate, and this bottom segment of the population will find gainful employment again.
With a new aid package finally approved, the budget deficit will continue to rise. The sixth Surprise is that both the Treasury and the Federal Reserve face up to the fact that we are in a period of Modern Monetary Theory. The ability to print our own currency and buy the bonds we are issuing to finance our deficits enables us to survive the difficult period we are facing. We have not had a budget surplus in more than twenty years and the prospect of having another one soon is dim. You hardly hear anyone say, “We can’t saddle our grandchildren with this debt burden” anymore. Nobody knows what will be the long-term effects of this debt accumulation. At some point, the increased liquidity would be expected to create inflation. While that has not happened yet, if it did, interest rates would probably rise, making further deficits too expensive to continue. Hopefully we won’t be faced with this dynamic until the economy has recovered and we are in a better position to address these long-term issues. There will be some investors who believe continued huge budget deficits and an ever-growing Federal Reserve balance sheet are irresponsible policies, so we think the price of gold is headed higher during the year. In that connection, cryptocurrencies will gain more respect as younger investors in particular become more comfortable investing in them.
Energy is the focus of Surprise Seven. Even as the OPEC consortium continues to limit production to keep prices high, we think demand for oil will rise substantially as vaccines become available. People will travel more, be it by car or other forms of transportation. The consumption of oil for industrial activity will increase. We estimate that the price of West Texas Intermediate could rise to $65 a barrel, substantially above the consensus. As a result, energy stocks and the high yield bonds of the companies involved would be expected to perform well. The energy sector once comprised more than 20% of the capitalization of the S&P 500, but comprises less than 5% now. We do not expect a return to its old highs, but we do think the sector will reward investors over the coming year.
The broad market finally gains some momentum in the second half when a majority of the population has been vaccinated and life is returning to normal. We believe the number of stocks participating in the rise will be much wider than consensus, and that is the Eighth Surprise. Because of overvaluation and what we consider to be excessively optimistic sentiment, we expect the market to have a correction in the first half. There are plenty of reasons to be concerned about the near-term outlook. Investors believe that the economic recovery, combined with vaccine progress, will allow them to invest with impunity. Consequently, investor optimism for equities is near an all-time high for households, foreign investors and mutual funds. The number of initial public offerings is surging, with many being priced at substantial premiums when they hit the market. Margin debt reached a record in November, as well. While most investors expect a 5%–10% pullback from time to time, often these declines go further than expected and we think the one in 2021 could approach 20%. The recovery will be strong, however, and our view is that the S&P 500 reaches 4,500 before the end of 2021. Cyclical and small capitalization stocks outperform. The large technology stocks that dominated the market last year become sources of cash and lag the indexes.
We are not so positive on the bond market. Signs of inflation begin to appear and our ninth Surprise is that the 10-year Treasury yield approaches 2%. The yield curve steepens, but real rates stay near zero as inflation rises modestly. The Fed extends the duration of its asset purchases in order to keep mortgage rates low and the housing market strong. And while we do expect both inflation and interest rates to rise, we believe we will continue to be in a generally low-rate environment for several years. We think the number of people looking for jobs will take pressure off excessive wage growth, while the continuation of people’s new routine of working from home will moderate major movements in rent prices. Rising commodity prices could be one potential source of inflation, but we don’t expect this to be particularly serious, especially given that the Fed’s “core PCE” measure excludes energy.
In the tenth and final Surprise, we think the dollar will be strong. This is one of our three Surprises that are the most out-of-consensus. The other two are thinking the Justice Department will soften its attempt to break up the major technology companies and the United States will develop a more harmonious relationship with China. In our view, America’s leading role in developing vaccines and strong recovery revive interest in bringing foreign investment into our securities markets and economy. The prevailing view is that a weak dollar will be caused by our continued and growing budget deficits and liberal monetary policy. Our interest rates, however, remain higher than those in Europe and Japan, albeit not those in China, and this may result in greater respect for the renminbi during the coming year.
Every year we have a few “Also Rans,” which are Surprises that don’t make the basic list of Ten either because we don’t believe they have a better than 50% chance of happening or they are not as interesting as the Surprises on the list. Until recently we had included a serious cyber-attack affecting banks, hospitals, government agencies and other institutions as one of the Ten Surprises. The recent news about Russian hacking put cyber on the front page of every newspaper and rendered it no longer “surprising,” so it became our first Also Ran. The second Also Ran involved Tesla. The stock’s market value now exceeds that of most of the other automobile manufacturers in the world combined. We think that Elon Musk negotiates a deal with a major auto manufacturer to buy the company using a combination of cash and stock. He pledges to end the production of internal combustion engine vehicles by this manufacturer by the end of the current decade.
Finally, the third Also Ran relates to the First Surprise, which is somewhat whimsical in nature. Donald Trump invites Kim Jong-un to participate in his television interview show. Kim announces before his appearance that he has a long-range nuclear missile capable of reaching Los Angeles. On the program, Trump convinces him not to test it anytime soon. He then looks directly into the camera and says, “People say I am the best negotiator!”
For years we have had an ambitious program of improving the United States infrastructure as a Surprise or Also Ran. Each of the last three presidents has promised to do something to remedy our decaying cities during his campaign, but little progress has been made. With the current budget deficit of several trillion dollars, the start of such a major program is a remote possibility. If such a program were undertaken, it would take time for proposals to come in, be reviewed and be implemented. Our competitiveness is suffering as a result.
So there they are: the Ten Surprises and the three Also Rans. Now let’s see how this important recovery year develops.
The views expressed in this commentary are the personal views of Byron Wien, Joe Zidle, and Taylor Becker 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, Joe Zidle, and Taylor Becker as of the date hereof, and neither Byron Wien, Joe Zidle, Taylor Becker, nor Blackstone undertake any responsibility to advise you of any changes in the views expressed herein.
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