The art of prophecy is difficult, especially with respect to the future.” Mark Twain.
- Forecasting is incredibly difficult, but year's end outlooks can be thought-provoking.
- Doug Kass' annual surprises offer a treasure trove of ideas for investors.
- Kass's surprises for 2022 correctly predicted key events, including the bear market and the Fed's hawkish interest rate policy.
- Kass' list for 2023 will be released next week.
December isn’t just about brightly wrapped gifts, and family laughs around the fireplace. It’s also when seemingly everybody on and off-Wall Street throws caution to the wind with forecasts for the coming year.
Few get it right and even fewer correctly handicap the year ahead consistently. Stocks often take unexpected twists and turns that defy logic (as well as the hopes and prayers of market participants), prompting economist Kenneth Galbraith to say, “We have two classes of forecasters: those who don’t know and those who don’t know they don’t know.”
The hit-and-miss nature of predicting market activity suggests forecasts should be considered a starting point for rigorous thinking rather than gospel. Predictions are less important (at least, to me) than the questions they raise and the research they prompt. If the predictions are correct, well, that’s gravy.
For this reason, I pay particular attention to outlooks written by folks who have decades of been-there and done-that experience. After all, if somebody with decades of market experience thinks a certain way because of how stocks or the economy is acting, I want to know about it!
Real Money Pro’s Doug Kass falls into this category of prognosticators.
A self-described contrarian with a calculator, Kass leverages lessons learned since his early days at Putnam in the 1970s to craft a list of surprises every year that often prove prescient.
Rather than tout those surprises as certainties, Kass focuses on possibilities under-appreciated by the masses. Last year, he wrote in “My 15 Surprises for 2022”:
“My Surprise List is not a set of forecasts. Rather, the List represents events that the consensus views as having a low probability of happening (25% or less) but, in my judgment, have a better than 50% chance of occurrence. In betting parlance, this is called an "overlay.”
Stocks drop, Fed hikes
His list last year had several surprises that were particularly on point, including surprise number three: “After an Early Year Rally to New Highs, The Stock Market Rolls Over.”
There’s no debating Kass nailed that one! The S&P 500 peaked in mid-January, and it’s been a “blood bath” for investors ever since.
High-valuation growth stocks have been particularly hard hit. The technology-heavy NASDAQ 100 index, comprising some of the world’s largest technology stocks, has tumbled over 30% this year. Many former high-flyers touted by the most aggressive portfolio managers, such as Cathy Wood’s ARK family of ETFs, have declined much more.
Those declines aren’t surprising to Kass's readers. Last year, he wrote:
“As private and public companies realize they need to tighten their belts, spending on ads on Meta (META) , Alphabet (GOOGL) , and Amazon (AMZN) declines. The tech mega caps suffer a significant de-rating…The loss of speculative monies expands into crypto and NFTs, which suffer large drawdowns…The "innovations" stocks that performed poorly in 2021 all but collapse in 2022 ( (ARKK) trades under $70/share - and that is the best-performing ETF in Cathie Woods' universe!). The fallout expands to venture capital, where liquidity tightens.”
Kass also nailed the Federal Reserve’s pivot from dovish “inflation is transitory” thinking to needing to whip inflation at all costs. Kass wrote:
“Powell Turns Hawkish - But Monetary Policy Fails to Dent Rising Inflation
Despite accelerated tapering and an attempt to signal slow and steady rate hikes, inflation accelerates well beyond expectations. By February, inflation is running close to 8%. Though comparisons are tough, inflation stays well above consensus expectations (sticking at above 5% this summer).”
When Kass wrote this surprise, the Consumer Price Index was below 7%, but by February, it was 7.9%, just shy of his target. His thinking inflation would remain high through summer turned out to undersell the situation, given headline CPI peaked above 9% in June.
Back to Kass:
“ESG investing, the complete reopening of the global economy and rising geopolitical tensions sends oil to over $110 a barrel.”
In early December 2021, West Texas Intermediate crude prices were under pressure, falling to a little over $62 per barrel on December 3rd. However, they began marching higher shortly after that, partly because OPEC and key global producers were hesitant to open oil spigots to meet growing global demand fueled by post-COVID easy money policies. Crude prices skyrocketed when Russia invaded Ukraine in February, peaking above $130 in March.
WTI prices have since fallen, but Kass’ prediction of an oil price surge because global demand outstripped supply and geopolitical tension was spot on. Energy stocks were unquestionably the best returning major sector this year, with the SPDR Energy Select ETF gaining over 50% through December 18 – a remarkable return, given the S&P 500’s nearly 20% drop.
Back to Kass:
“The U.S. labor shortage intensifies, and wages grow +6%. The shift from "goods to services" demand post-Covid actually causes more inflation as, surprisingly, service prices accelerate across the board.”
Job growth has been one of the most vexing things working against the Federal Reserve’s attempts to wrestle inflation to the mat this year.
As of October, the most recently reported month, there were still 10.3 million open jobs in the United States, according to the Job Openings and Labor Turnover Summary report (JOLTS).
With unemployment at only 3.7% and so many jobs unfilled, wage growth has continued to pressure inflation, rising above 6% this spring and totaling 6.4% in November, according to the Atlanta Fed’s Wage Growth Tracker. As a result, while the price of goods has retreated as the year has progressed, services sector inflation has remained stubbornly elevated,
Back to Kass:
“Powell ends up more Volcker-like than anyone predicted. The Fed Chair turns very hawkish and focuses on inflation - not jobs or stocks. But it is too late, and the monetary pivot fails to materially reduce an elevated level of inflation as years of monetary excesses are not easily reversed.”
Nobody was comparing Powell to Volcker exiting last year, but it’s a different story this year. Inflation is the highest since Volcker’s rein in the 1980s, so the Federal Reserve has abandoned its previous “transitory” view of inflation, declaring outright war on inflation via a series of rate increases.
In March, it began with a tepid 0.25% increase, bringing the Fed Funds Rate to a still-too-low level of 0.25% to 0.50%. Since then, however, Powell has taken Volcker’s “hike inflation into submission” strategy to heart.
The central bank has increased rates every meeting since March, including four separate 0.75% increases through November. Following its 0.50% increase earlier this month, the Fed Funds rate range now stands at 4.25% to 4.5%, miles above when Kass penned his thoughts.
The Smart Play
Those weren’t the only surprises that panned out for Kass. He also predicted value stocks would outperform growth stocks (they did) and that Amazon’s founder, Jeff Bezos, and Tesla’s (TSLA) mercurial CEO Elon Musk would “Battle It Out to See Who Can Set The Record for Biggest Loss of Personal Fortune in a Single Year.”
As of last week, Musk was “winning” the title, having seen his fortune fall by over $100 billion through December 12. Bezos's fortune has declined by almost $79 billion. Eye-popping figures, for sure.
Of course, there are no market crystal balls, but Kass's experience and track record make me eager to see what surprises he sees as possibilities in 2023.
Does Kass' think stocks may find their footing? How does he feel about the Fed's hawkish policy and recession? Will commodities be a haven again, or will bonds be king? Stay tuned! His complete list of surprises for 2023 will be revealed to Real Money Pro readers next week, so we'll know what big surprises he thinks could be in store for us next year soon.