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Thursday, January 06, 2005

Byron Wien's "top ten surprises" for 2005 

Morgan Stanley's chief investment strategist, Byron Wien, has issued his annual list of "top ten surprises" for 2005. One might well ask how something can be a surprise if Morgan Stanley's chief investment strategist is predicting it. Wien defines a surprise as an event that "the consensus" would assign a less than 1/3 probability of occurrence during the year, and he assigns a probability greater than 50%. So think of this as a list of events that he thinks are more likely to occur than the conventional wisdom suggests. Wien's predictions are in italics, and the rest is TigerHawk commentary.

1. Crude oil takes the trophy for the most volatile commodity of the year. After dropping to $30 a barrel, it rises to $60 as a result of supply/demand imbalances and disruptions in shipments. There are no drawdowns of the Strategic Petroleum Reserve, but drilling in the Arctic National Wildlife Refuge passes Congress.

Without knowing anything about the oil market, that it will be the most volatile commodity of the year hardly seems like a reckless prediction. Nor does Wien's price range seem unreasonable. Even at $60 a barrel, oil is one of the best deals around. In any case, it almost never hurts to own a couple of integrated oil stocks. Buy XON and BP and hold them forever.

2. While the Bush Administration continues to argue that it supports a strong dollar policy, it also maintains that market forces should be allowed to set the level of the currency. The hoped-for orderly decline gives way to a sharp drop, and the euro goes to 1.50 and the yen to 85. Europe and Japan call for a second Louvre Accord to reverse the trend. In spite of the currency weakness, the US trade deficit continues to rise.

This is not high on the courageous list either -- it may in fact meet Wien's criteria for a "surprise" insofar as futures prices do not predict such a weak dollar, but further dollar weakness strikes me as very plausible. If you believe Wien, move some of your 401(k) investment into an "international" fund.

3. The yield on the 10-year US Treasury rises to 6.00% in the second half of the year. Among other causes, Japan and China reduce their purchases of US bonds. Although inflation remains moderate and the economy is not overheating, the Federal Reserve raises rates at every meeting and the federal funds rate ends the year at 4.25%. Greenspan admits that “real rates have been too low for too long.”

Indeed.

4. The US equity market goes nowhere after two years of gains. Responding to higher interest rates, excessive investor optimism, continuing international tension, a declining currency, and an overextended consumer, the Standard & Poor’s 500 ends the year flat in spite of a reasonably strong economy and corporate earnings improvement.

If you believe his predictions of rising interest rates and a declining dollar, you sort of have to believe that the stock market will suck.

5. Resisting pressure from its trading partners, China refuses to change its currency system. It rejects the “basket of currencies” approach, saying it prefers to remain pegged to the dollar because of a commitment to economic stability, employment increases, and a continuation of reforms. China’s growth stays near 9% as it expands its infrastructure and industrialization westward. Commodity prices persistently rise, and chemical stocks like Lyondell and Dow do especially well.

6. Japan slips back into recession as the yen strengthens and exports to China prove inadequate to keep the economy going. Investors begin to question the ability of Japan to thrive as a high-cost producer in a low-cost region. The Nikkei 225 approaches 10,000 again.

7. Vladimir Putin’s hard-line policies finally prove too much for the Russian people. Revelations of widespread corruption on top of the Ukraine election controversy precipitate a second Russian Revolution and Putin resigns. The economy slumps, the ruble weakens, and the Russian market declines 25%.

This seems unlikely. I know very little about Russian politics, but Putin will remain in power for the same reason that George Bush did -- fear of al Qaeda. The Russian people will want to stay the course, and they know that it takes a tough man to do that.

8. While oil and gas producers and refiners and marketers do well in the US equity market, oil service and other energy infrastructure stocks are standouts. Weatherford and Halliburton are market leaders. Coal also continues its resurgence, and Peabody and Consol Energy appear to have substantial upside.

Dick Cheney's favorite charities should be pleased.

9. Following a terrific 2004 harvest that drove some agricultural commodities to distressed levels, the summer growing season is alternately too cold or too hot, rain is infrequent, and worldwide food demand increases. Corn, soybean, and wheat prices rise sharply. Entering the year with large inventories, Archer Daniels Midland and Bunge are big winners.

Wien makes a toin coss. How on earth does he know?

10. The Bush Administration overreaches on domestic economic legislation. Citing the high transition costs and the uncertain benefits, both Republicans and Democrats defeat partial privatization of Social Security. The year isn’t a total washout, however. Congress confounds the skeptics and puts limits on plaintiffs’ lawsuit damages. Concern about a doctor shortage outside of major cities convinces a number of Democratic members to support tort reform.

I agree. The old people are going to sell the trial lawyers down the river, and that will be a beautiful thing.

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