Bankrupt Sears, Brexit Becomes Bremain, & Bye-Bye 'Peak Auto' - Doug Kass' 15 Surprises For 2017
Tuesday, 27 December 2016
The core thread of next year's relatively downbeat "surprises" from Seabreeze Partners' Doug Kass is that the *crowd is wearing Trump-colored glasses *and that the single-*biggest surprise is how quickly the bloom comes off the Trump flower*.
In 2017 Donald Trump no longer will be seen as an invincible politician or a self-proclaimed stock market savior (see Surprise #3). Rather, he will learn, the hard way, the difficulty in governing and what Mario Cuomo meant when he said, "Campaign in poetry, govern in prose."
*The market risks and Surprises for next year almost all will be to the downside.*
Risk will happen fast in 2017.
Will The Dude Abide?
"This is not 'Nam. This is bowling. There are rules."
--Walter Sobchak, "The Big Lebowski"
"This aggression will not stand, man."
--The Dude, "The Big Lebowski"
At the time of its release, the initial reviews of the movie "The Big Lebowski" started off poorly, much like Donald Trump's candidacy. But, over time, like The Donald, the popularity of the movie became cult-like, owing to its eclectic soundtrack, unconventional dialogue, dream sequences and idiosyncratic characters. Indeed, two years ago the movie was selected for preservation by The Library of Congress, which deemed the film "culturally, historically and aesthetically significant."
*2017 will be the year of The Dude -- not Jeffrey "The Dude" Lebowski (played by Jeff Bridges), but, the other dude, President-elect Donald Trump, who, much like in 2016, will dominate the news and the financial markets like no other man in history.*
So, as Walter told the Dude, "Come on Dude. Screw it, let's go bowling (for some surprises in 2017)..."
*Surprise #1: The New Year Starts Out On a Sour Note and Sets a Negative Market Tone for the Year as Sears Holdings Declares Chapter 11 Bankruptcy in Early January 2017.*
Sears Holdings (SHLD) operates more than 1,500 stores and employees 178,000 people. The company's sales have declined for 20 consecutive quarters.
Sears' shares hit a 52-week low on Friday after reporting a devastatingly bad third quarter. While Chairman and CEO Ed Lampert has pulled several restructuring/asset sale rabbits out of his hat, he has run out of tricks.
During the second week of January, Sears' day vendors are due to be paid. Available credit for the company has dropped to below $200 million -- enough for the past year, but with EBIT losses of more than $1 billion, 2017 is likely out of the question.
Tens of thousands of the company's workers likely will be eliminated after bankruptcy. As the company is a major tenant in many retail malls around the U.S., a Sears bankruptcy further will exacerbate the sales indigestion we are seeing in major and minor malls, creating havoc in the shares of mall REITs.
President-elect Trump reluctantly rescinds the notion of a 10% border tariff, recognizing the already- disruptive impact of the Sears bankruptcy on the U.S. retail industry and economy. Retail shares rally vigorously based not only on the abandonment of the import tariff but also on the hope and expectation of market share gains that follow the Sears bankruptcy.
*Surprise #2: The Trump Election Victory Establishes an Important Precedent and Is Followed by a Broad and General Movement in Which Prominent Businessmen, Celebrities, Sports Figures and Others Without Prior Political or Military Experience Consider Political Office.* Among the individuals who initially express an interest in putting their hats in congressional and senatorial contests are Mark Cuban, George Clooney, Neil Patrick Harris, Ashton Kutcher, Justin Timberlake, Ellen DeGeneres, Oprah Winfrey, John Bon Jovi, Kevin Hart, Garth Brooks, LeBron James (who announces his 2018 retirement) and Peyton Manning.
Late in the year, Starbucks (SBUX) Executive Chairman Howard Schultz makes initial (and overt) plans aimed as an early attempt to become the 2020 Democratic presidential candidate and becomes a big favorite for the nomination as major donors, high-profile party operatives, powerful former politicians and leading current Democratic congressional members begin to rally around him.
*Surprise #3: Shortly After the Inauguration, Donald Trump's Security Advisers Convince Him To Cease Tweeting and to Close His Twitter Account (@realDonaldTrump).* Shares of Twitter (TWTR) immediately fall by 20% in one day. In the face of failed operating strategy moves that lead to large drops in monthly average users, continued management departures and impatience on the part of its initial founders and investors, Twitter is sold for between $10 and $12 a share -- well under the current share price.
There will be no more jumping the shark, no more tweets like this one from Monday evening from an invincible politician and investment savior:
The world was gloomy before I won - there was no hope. Now the market is up nearly 10% and Christmas spending is over a trillion dollars!
— Donald J. Trump (@realDonaldTrump) December 26, 2016
*Surprise #4: "The Unartful Deal" -- The President-elect's Popularity Quickly Fades as "The Dude (Doesn't ) Abide." * A series of authoritarian executive orders reversing the Obama legacy (affordable care, environmental regulations, birth control, easing of gun control restrictions and immigration among them) results in a coalition of Black Lives Matters activists and college students who launch an extended and boisterous national protest in major cities around the country. Trump imposes curfews but the demonstrations become more violent.
Thanks to a lack of policy depth and an ability and patience to understand and execute complex and cohesive policy, a murky strategic vision and an inability to work with the Senate and House, Trump and his foreign policies of protectionism and suspension of support for NATO upset the world order and create a global crisis. His national civil policies contribute to domestic instability. These policies hurt and dominate the financial markets for the entire year.
By some token, Trump turns out to be more like a Democrat than a Republican and governs like one. While his goal of a massive infrastructure bill is achieved by reaching across party lines to make a budget-busting deal with Democrats (it nonetheless takes time and is slow to be implemented), his Obamacare replacement is all carrots and no sticks and a budget buster. Mainstream Republicans squawk against more spending and deficits as their demands for revenue neutrality are ignored by the president.
Combining proposed fiscal initiatives with promised spending on veterans and the military and individual and corporate tax cuts, the 2018 projected deficit runs to 9% of GDP at the peak of the cycle.
Slowly and over the course of the year, the right wing of the Republican Party begins to abandon Trump (there is no wall to be built and the jobs market fails to improve as the payoff for infrastructure is delayed well down the road). Moreover, lower corporate tax rates end up feathering the bed of executives as they predominantly are used in corporate stock repurchases, for merger and takeover activity and for dividend increases, trickling up and not trickling down.
The Average Joe who sought the help of a Trump presidency begins to feel abandoned. More and more, Trump is seen as an elitist and not representative of our society by the very citizens who voted him into office.
The ensuing debate and reduced popularity of the administration leads to little movement toward the revision of Dodd-Frank as Trump is fighting wars on numerous fronts.
In time, the Alt Right adopts a new chant -- "Lock him up" -- borrowing from the Hillary Clinton "Lock her up" chants. In reaction, Trump throws a few hail Marys toward the end zone to the Republican right by nominating Ted Cruz for the Supreme Court and by provoking Iran in an attempt to show his might.
The Republican establishment (Paul Ryan et al) also grows more hostile, causing a deep rift between the Republican Party and the presidency.
Trump's cabinet of independent billionaires and generals begins to behave increasingly impatient with policy and their roles and become less cohesive and supportive participants of the administration. The first official departure is Secretary of Commerce Wilbur Ross, who resigns near year-end (citing "health problems"). Several others follow and return to the private sector in early 2018.
WikiLeaks moves its target from Hillary Clinton to Donald Trump and exposes his relationships with governments unfriendly to America and highlights his unethical and immoral (business and personal) behavior from the past. WikiLeaks and investigative reporters from The Washington Post and New York TImes also reveal embarrassing information about certain members of the president's Cabinet.
"An old tiger sensing the end are their most fierce and go down fighting."
--Sean Connery (as Allan Quatermain) in "The League of Extraordinary Gentlemen"
Though hostile to the mainstream of the Republican Party, protectionism and trade barriers are about the only thing that Trump can offer his core supporters in Industrial America who have fallen on bad times. He does not disappoint them. Meanwhile, European leaders, taking Trump's role, eliminate free trade agreements and close borders to immigrants. Marine Le Pen, the new French president, proposes leaving the European Union. Germany's Angela Merkel loses popularity and her election (see Also Ran #4).
After labelling China a "currency manipulator," Trump imposes outrageous tariffs on Chinese exports. In response, China devalues the yuan dramatically, blocks iPhone sales and cancels Boeing (BA) and Lockheed Martin (LMT) orders. China enters a recession and world trade stalls, accelerating a domestic economic downturn.
The president pulls out of NAFTA and cancels U.S. membership in the United Nations and NATO.
It is not "Morning in America." Rather, Donald Trump makes uncertainty and volatility great again.
Stocks exhibit a volatility and randomness in price action rarely ever seen -- 1% daily moves become common place.
The S&P Index has a high of 2375 (up 5%) for the year (Friday's close was 2264) and a low of 1815 ( down 20%), closing the year closer to the low end of the annual price range (down 15%).
*Surprise #5 :Trump Grows Restless After Some Failed Initiatives and Loss of Support.* He Begins to Lose Interest in His Job After He Finds Out How Hard It Is to Get Anything Done and Becomes The First Part-Time President in History. Vice President Mike Pence gains more responsibilities, but a splintered Republican Party begins to unravel and little effective legislation is passed.
Steve Bannon begins to battle fiercely with Pence and is the first to leave the administration in late summer.
A frustrated Trump becomes torn as his wife, Melania, departs Washington, D.C., and returns to her New York City residency. The cover story in The New York Post poses the rhetorical question, "Has Melania Been Trumped?"
With his wife back at Trump Tower, a leg back in his business empire (a blind trust is never formed) and the other leg in the presidency, Trump is conflicted, and ultimately becomes ever more brash and unpredictable as our country's first part-time president.
Trump becomes more insular, angry and detached. "It's a Family Affair" as Trump retreats to the comfort and company of his three older children.
Michael Moore's prediction on the Trump presidency's half-life may prove accurate in 2018 as"the hunter is captured by the game."
*Surprise #6: Early in 2017, Higher Wages, Rising Interest Rates and Higher Input Prices Squeeze Profit Margins. *Bond vigilantes take the 10-year U.S. note to more than 3% early in the first quarter. However, despite a good start to the year (nearly 3% real GDP growth in the first quarter), by March "Peak Confidence," "Peak GDP" and "Peak Profits" crystallize as business activity begins to move downhill. Profits begin to decline in the second half of 2017, in marked contrast to consensus expectations of a "hockey stick" in growth. Domestic GDP growth falls below 2% for the full year.
Importantly (and as mentioned earlier), fiscal initiatives -- like the monetary stimulation before them -- fail to trickle down and, again, trickle up to the wealthy. Middle America, at the core of Trump's support, grows ever more uneasy.
*Surprise #7: The Stock Market Makes Its High in the First Two Weeks of January and Goes Downhill the Rest of the Year, Ending Down 15% for 2017.* A Sears(SHLD) bankruptcy, rising inflation, higher interest rates, pressure on middle-class disposable incomes (more "Screwflation"), disappointing corporate profits, ineffective fiscal initiatives, the lack of a strategic vision of the new administration, an expanding wealth and income gap and a rudderless White House weigh on stocks.
*Surprise #8: There Are No Fed Rate Increases in 2017. *Amid a background of domestic and global chaos, Fed Chairwoman Janet Yellen refuses to act against the stock market and for months the Fed --with a huge mark-to-market balance sheet loss -- is seen as hopelessly behind the curve as the 10-year U.S. note yield rips through 3% in the first two months of the year.
*Surprise #9: Yellen Resigns Under Pressure From the New Administration. *After prodding and excessive brow-beating from the Trump administration, the Fed chairwoman rescinds her promise to stay on until her term expires at the end of January 2018 and leaves six months prematurely.
*Surprise #10: "Quantitative Easing Endless" Becomes Reality and the Fed Sets the 10-Year Yield at 1.5% to 1.75%.* Following the new administration's aggressive attempts to embark upon a testosterone-driven fiscal agenda -- shaving corporate tax rates, reducing capital gains taxes and lowering individual tax rates -- the 10-year U.S. note yield moves above 3% and stocks falter badly early in the year. Credit markets seize up and the Fed duplicates the Bank of Japan's yield curve control attempts by fixing the 10-year U.S. note yield at between 1.5% and 1.75%. The large decline in equities is momentarily arrested and bond prices exhibit their sharpest weekly price gain in almost a decade.
*Surprise #11: "Brexit" Turns into "Bremain." *Populism around the world moves the European Union to be more cooperative -- with concessions on immigration/border controls and passporting rights of U.K. financial service companies, among other things -- with England while adopting harsh border controls of its own.
The Parliament turns down "Brexit."
*Surprise #12: In a Weakening Stock Market, the Burgeoning ETF Business Suffers Instability After a Series of Stock Market Mini "Flash Crashes." *The wild expansion in the number of ETFs abruptly ends and more than half the ETFs close in 2017. A congressional committee is set up to explore the industry's problems and market impact. Public companies that are dependent upon ETFs (e.g., Wisdom Tree and, to a lesser degree, BlackRock) are among the worst stock performers for the year.
*Surprise #13: Drill, Baby, Drill.* Multistage hydraulic fracturing as applied to horizontal wells becomes a global phenomenon, expanding to Russia, Saudi Arabia and Argentina, among others. Companies everywhere react to the OPEC freeze and hoped-for boom with too much drilling as nobody wants to miss out. Neither prove out. After a spike to $60 a barrel early in the first quarter, oil retreats to $35 a barrel. The junk bond market is hit hard in the last six months of the year.
*Surprise #14: Apple is Still Crapple.* Apple's (AAPL) iPhone 8 disappoints and the company guides down sales and profit forecasts. After the Trump-led repatriated cash initiatives come to pass, Apple finally recognizes the need to create new sources of income and acquires Time Warner (TWX) by outbidding AT&T (T) . But Apple's valuation suffers in recognition of "Peak Smart Phones" and China's pushback and the company's price/earnings multiple falls to under 9x and its share price moves back under $90.
*Surprise #15: Goodbye, "Peak Autos" -- Car Industry Sales Don't Peak and Have Another Ramp Higher:* Though housing activity falters and economic growth disappoints, the car industry is uncharacteristically resilient. General Motors (GM) and Ford (F) are among the best stocks of the year as automobile technological innovation and improvements generate what in another industry would be called an "upgrade cycle" and the pent-up demand of an aging auto fleet counters broader economic weakness. Ergo, the peak auto cycle is delayed for another cycle, even despite slowing economic growth. Aided by this upswing, a better positioning than Ford across product lines and geography and a much lower price for energy products, GM earns $8 a share and turns out to be the best-performing stock in the S&P Index.
*Five Also-Ran Surprises*
*Also-Ran #1: A Major Hedge Fund Known for Its Transparency (While Offering No Real Transparency) Turns Out to Be a Ponzi Scheme:* "Peak Hedge Funds" is further confirmed and industry redemptions multiply after the ruse is uncovered. Hedge fund assets halve from the peak.
*Also-Ran #2: Pershing Square Shutters:* Despite a large permanent base of capital and Bill Ackman's strong record of resilience (and stubborness!), Pershing Square closes and Ackman heads off to teach at Harvard Business School after his acrimonious divorce and another poor year as Chipolte Mexican Grill (CMG) and Valeant Pharmaceuticals(VRX) crap out and Herbalife (HLF) heads higher. Many other high-profile hedge funds close as industry redemptions provide a disruptive impact to the markets throughout the year.
*Also-Ran #3: A Large Silicon Valley Fraud Is Discovered:* Following this revelation, private equity markdowns are unprecedented, hurting large endowments such as those at Harvard and Yale and further exacerbating hedge fund redemptions.
*Also-Ran #4: The Trump Victory Heralds More Political Surprises Around the World:\*
· Marine Le Pen becomes Le President of France.
· The Far Right wins in The Netherlands as Geert Wilders' Party for Freedom wins the general election.
· The anti-euro far right Alternative for Germany (AfD) raises anti-immigrant feelngs in their country. Though not building a majority, AfD forms political coalitions and its influence grows disarmingly strong into the October 2017 election.
· Scotland becomes independent.
*Also-Ran #5: Gold Shines:* Domestic strife/chaos and an intensification of conflict between the new administration toward Iran and China result in investors and traders seeking protection in a period of heightened political risk. Unexpectedly -- at least based on the yellow metal's continued downtrend in prices over the last several years -- gold goes from goat to hero.
Kew-Forest School in Queens (Where's Donald "The Dude" Trump?)
Some final words.
*My outlook for 2017 is more gloomy than in years.*
*To me, the biggest surprises are (1) the abundance of complacent sheep that populate our financial markets today, (2) the rapidity in which the bloom comes off the Trump flower next year, and (3) that the market actually may do what is unexpected in 2017*.
The Republican Party becomes divided and Trump's policy support loosens. Even the newly elected president's "A Team of Rivals" cabinet with vastly different philosophies and backgrounds becomes splintered, full of tension and conflicted, much like an episode of "The Apprentice." Unlike President Lincoln (who neither lacked for self-confidence nor needed to be the only voice in the room) and his ornery set of advisers, Trump's management style of an "Apprentice-like" administration does not produce constructive and cohesive policy.
With little strategic vision and a limited ability to effectively govern, the Trump administration's popularity quickly wanes as the trade-off from a slower growth world to a late-cycle policy experiment to stimulate growth fails.
Off of Twitter, absent regular press conferences and the delay/failure of policy, Donald Trump by year-end 2017 will be less ubiquitous and harder to find than he has been for the last 18 months and more like Where's Waldo? (see picture above -- can you find the young Trump?)
*All of which gets me back to the three questions that I have asked myself every morning over the last two to three years. These questions seem more appropriate to ask today than ever:*
· In a paperless and cloudy world, are investors and citizens as safe as the markets assume we are?
· In a flat, networked and interconnected world, is it even possible for America to be an "oasis of prosperity" and a driver or engine of global economic growth?
· With the G-8's geopolitical coordination at an all-time low, how slow and inept will the reaction be if the wheels do come off?
-- Doug's Daily Diary, I'm Bearish in Word and Deed (March 24, 2016)
Think about these questions as you approach investing in 2017 and consider embracing the contrary and even some of my "probable improbables" for a portion of your invested assets.
*Risk happens fast in 2017.*
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