Blackstone Quarterly Webcast: The Ten Surprises of 2021
We’re pleased to offer our first-quarter webcast, “The Ten Surprises of 2021,” featuring Byron Wien, Vice Chairman of Private Wealth Solutions, and Joe Zidle, Chief Investment Strategist.
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The Ten Surprises of 2021
The preparation of the Ten Surprises, now in its 36th edition, is a long process. It begins in the summer when the four (now five) Benchmark Lunches give us a sense of where the consensus is. That is followed in the fall by a series of focus groups and sifting through hundreds of research reports and newspaper and magazine articles to try to identify and prioritize imaginative ideas. Joe Zidle and Taylor Becker are active participants in this effort. It all comes together in mid-December, but we’re still tweaking the Surprises until Christmas.
Clearly 2020 was a year like no other. While the Covid-19 virus had begun to ravage China starting in late 2019, we first viewed it as one of a long series of Asian viruses that had afflicted that region over the years, but had not become a serious problem elsewhere. How wrong we were! Covid became the most important world event of 2020 and its secular impact is likely to be with us for years. The virus influenced the Ten Surprises in various ways. The ones we got right benefited from circumstances different than those we had anticipated. The ones we got wrong were mostly because of the unforeseeable effects of Covid. Overall, it was not a good year for our Surprises, but we were all pleased with how well the equity market did in spite of this spring’s recession, the lockdowns, numerous business closures and hundreds of thousands of American fatalities. We are not discouraged by the outcome of last year’s Surprises and our hope is that the 2021 list below will prove to be more prescient.
First, a review of the Ten Surprises of 2020. The Strategy Team defines a surprise as an event which they believe has a better than 50% chance of taking place, but professional investors would only assign a one out of three chance of happening.
In the first Surprise we said that the economy would have a disappointing year, but a recession would be avoided. We had a sharp downturn in March and April, but a “V” shaped recovery followed, and it was one of the shortest recessions ever recorded. While employment is only roughly halfway back to its 2019 level, income is around three-quarters of the way back as people have found a way to effectively work remotely and companies continue to pay their white-collar employees. Those who have had to show up for work have taken the necessary precautions to do so, but many in lower-paying segments of the economy, like restaurants, have suffered. Fiscal and monetary relief (not “stimulus”—which implies spurring growth, rather than simply filling a gap) has helped many people and must continue, but the economy has failed to develop any convincing momentum on its own. The Fed did lower the Federal funds rates as we expected, and President Trump deferred but did not cut payroll taxes because Congress would not approve it.
We expected the Senate to shift to a Democratic majority in the second Surprise. The Georgia runoff will determine the accuracy of that one. We were right that inequality and climate change would be important in the November election, but it is questionable how much they helped to elect Joe Biden. President Trump was impeached but not removed from office. Nothing revealed in the trial, though, had the influence on state and local elections that we expected. In the end, the country was even more divided politically than we appreciated.
China was the focus of the third Surprise. We did not expect China to become more hostile toward the West during the year, but we did think that there would be little progress toward a Phase Two deal. We thought that limits on China’s ability to acquire intellectual property would not be imposed and there would be separate standards for 5G technology. We were right in saying that U.S./China economic codependence would erode, but wrong in thinking that both China and the U.S. would keep their hands off Hong Kong.
In Surprise Four we said that the prospect of a self-driving car would be pushed further into the future because a series of accidents would cause a major manufacturer or technology company to terminate its effort. Uber did announce the spin-off of its autonomous vehicle unit, which was clearly a sign of disenchantment with the concept. Otherwise, we think autonomous vehicles made little progress during the year, but that was more because of preoccupation with Covid than any other factor.
We didn’t do well in Surprise Five. We expected Iran to step up its attacks on Israel and Saudi Arabia. While Iran did continue to develop its nuclear weapons capability, efforts by other countries in the Middle East to establish relations with Israel generally softened tensions in the region. It appears to be the intention of the Biden Administration to negotiate with Iran in some way, but it’s uncertain whether that will be successful. Iran is still suspicious of the West after the assassination of one of its top nuclear scientists. The Strait of Hormuz was not closed, and the price of oil went down, not up.
We did pretty well in Surprise Six in spite of the pandemic. The S&P 500 exceeded our target of 3,500 despite weaker earnings than expected at the beginning of the year. We were right to think fiscal and monetary policy would play a role in the rise in the market and that market volatility would increase with corrections of greater than 5%. Our assessment of latent investor enthusiasm turned out to be correct.
We got Surprise Seven mostly right. We said the big tech companies would be subject to more political scrutiny and social blowback. The Department of Justice’s case is based on concerns that the companies have stifled competition. The public objects to the sale of personal information to advertisers. This time around, because of broad support, it looks like the effort to break several companies up is going to make real progress, in contrast to earlier efforts to break up IBM, Apple and Microsoft. Even individual states and Europe are on board.
We tried to tackle Brexit in Surprise Eight. Optimistic about a deal with the European Union, we thought a workable compromise would be found. As a result, we believed that the United Kingdom would be a good place to invest, and that the pound would rally. We were right that the U.K. would secure an agreement by the end of the year and that the U.S. and Asia would outperform Europe, but the virus changed the calculus of the U.K.’s economic outlook. In terms of Covid impact, Britain has been among the most vulnerable countries with off and on lockdowns.
We were too pessimistic about the bond market in Surprise Nine. Like many, we expected the continued growth of the economy to push Treasury yields higher, but a combination of fiscal and monetary accommodation and the search for yield by defensive investors kept yields low. We thought supply and demand would drive yields up, but these factors contributed to lower rates.
Finally, in Surprise Ten we said that Boeing would make progress in getting the troubled 737 MAX back into the sky and it would carry passengers on commercial flights by the end of the year. American Airlines scheduled both non-commercial and commercial flights using the 737 MAX between Miami and New York in December. Other airlines have continued to place orders, and while the plane has not yet attracted widespread support, this is more likely attributable to Covid-related uncertainty in the airline industry.
Each year we have a few Surprises that don’t make the basic list of Ten. The Also Rans are potential Surprises that we deemed less probable or less relevant than the Ten we selected. Last year we had five of them. We thought that the political and economic problems in India would not keep the stock market there from performing well, and while the Sensex is up for the year, it has underperformed a basket of emerging market equity indices. We were skeptical that artificial intelligence would cause major additional job losses, and that appears to be the case so far, but the data are confused by the virus. We thought Putin’s leadership in Russia would be challenged because of social unrest, and that has not happened. We expected that more turbulence and instability in the emerging markets would lead to weaker currencies. That’s generally been right, but the virus has been the cause. We also expected North Korea to quiet down as a hot spot, but not give up its nuclear stockpile. We did think Kim Jong-un might be convinced to discontinue further nuclear development work, but no progress has been made there.
Every year Joe Zidle, Taylor Becker and I always have a lot of help with the Ten Surprises. George Soros shares his view of the macro environment, as he has for most of the 36 years that the Surprises have existed. Gideon Rose and Dan Kurtz-Phelan of Foreign Affairs at the Council on Foreign Relations comment on the various trouble spots around the world. The Third Thursday Group of former Wall Street research directors provide both insightful and outrageous ideas.
In the end, we take responsibility for the Surprises, however good or bad. While the year wasn’t a total washout, it was far from one of our best. Now let’s take a look at the Ten Surprises of 2021.
- Former President Trump starts his own television network and also plans his 2024 campaign. His lead program is The Chief, in which he weekly interviews heads of state and CEOs with management styles like his own. His virtual interview with Vladimir Putin draws more viewers than any television program in history.
- Despite the hostile rhetoric from both sides during the U.S. presidential campaign, President Biden begins to restore a constructive diplomatic and trade relationship with China. China A shares lead emerging markets higher.
- The success of between five and ten vaccines, together with an improvement in therapeutics, allows the U.S. to return to some form of “normal” by Memorial Day 2021. People are generally required to show proof of vaccination before boarding airplanes and attending theaters, movies, sporting events and other large gatherings. The Summer Olympics, postponed last year, are held in July with spectators allowed to physically attend.
- The Justice Department softens its case against Google and Facebook, persuaded by the argument that the consumer actually benefits from the services provided by these companies. Certain divestitures are proposed and surveillance restrictions are applied, but the broad effort to break them up loses support, except in Europe.
- The economy develops momentum on its own because of pent-up demand, and depressed hospitality and airline stocks become strong performers. Fiscal and monetary policy remain historically accommodative. Nominal economic growth for the full year exceeds 6% and the unemployment rate falls to 5%. We begin the longest economic cycle in history, surpassing the cycle that lasted from 2010 to 2020.
- The Federal Reserve and the Treasury openly embrace Modern Monetary Theory as their accommodative policies continue. As long as growth exceeds the rate of inflation, deficits don’t seem to matter. Because inflation increases modestly, gold rallies and cryptocurrencies gain more respect during the year.
- Even as energy company executives cut estimates for long-term growth, near-term opportunities are increasing. The return to “normal” increases both industrial activity and mobility, and the price of West Texas Intermediate oil rises to $65/bbl. Rig counts increase and energy high yield bonds rally soundly. Energy stocks are among the best performers in 2021.
- The equity market broadens out. Stocks beyond health care and technology participate in the rise in prices. “Risk on” is not without risk and the market corrects almost 20% in the first half, but the S&P 500 trades at 4,500 later in the year. Cyclicals lead defensives, small caps beat large caps and the “K” shaped equity market recovery unwinds. Big cap tech is the source of liquidity, and the stocks are laggards for the year.
- The surge in economic growth causes the 10-year Treasury yield to rise to 2%. The yield curve steepens, but a concomitant increase in inflation keeps real rates near zero. The Fed wants the strength in housing and autos to continue. As a result, it extends the duration of bond purchases in order to prevent higher rates at the long end of the curve from choking off credit to consumers and businesses.
- The slide in the dollar turns around. The post-vaccine strength of the U.S. economy and financial markets attracts investors disenchanted with the rising debt and slower growth of Europe and Japan. Treasurys maintain a positive yield and the carry trade continues.
The “Also Rans”
- Cyber-attacks, mostly from Eastern Europe and the Middle East, begin to have an economic impact. Bank account information is invaded and distorted, patient records are lost at hospitals and credit collection companies can’t keep track of customer purchases. Those tampering prove to be more skillful than those protecting the integrity of the data and the dislocation cost becomes significant.
- Tesla acquires a major global auto manufacturer in a transaction that involves a combination of cash and stock. Elon Musk is the CEO and pledges to eliminate the internal combustion engine by the end of the decade.
- Kim Jong-un threatens to explode his latest long-range missile, capable, he says, of reaching Los Angeles. Trump invites him onto TV and explains that Kim will be a better person and the world will be a better place if he works with other countries rather than threatening them. Kim agrees to stop testing long-range missiles. Trump looks into the camera and says, “People say I am the best negotiator.”
It is probably useful to reflect on what we didn’t include. We put the cyber Surprise in the Also Rans because, with the current Russian revelations, it is part of the current news and even though it is a real threat, it is no longer a surprise. We also did not discuss infrastructure. The last three presidents have all promised an infrastructure program and very little work has taken place. It would be a surprise if a major program were implemented, but we don’t see that happening.
We will discuss the 2021 Surprises in detail in the February essay.
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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