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Dec Consumer Confidence at 52.5 was below estimates of 56.3 and down from 54.3 in Nov. Both the Present Situation and Future Expectation components fell. While we’ve seen signs of a better labor market, especially with initial jobless claims of late, the improvement was not very evident in today’s data. Those that said jobs were Plentiful fell to 3.9 from 4.3 and those that said jobs were Hard to Get rose .5 pt to 46.8, the highest since Feb. Positively, those that said Business Conditions were Normal rose to a high in this recovery but things were not incrementally better as those that said things were Good fell to the lowest since Feb. Those that plan to buy a home rose .1 pt but remained punk at near the lowest since ’82. Those that plan to buy a car fell to a 6 month low. One yr inflation expectations rose .2% to 5.3%, the most since May. Bottom line, a blah report but consumers took out their wallets this holiday season anyway.

The Oct 20 city S&P/CS home price index fell 1% vs expectations of a fall of .6%. The y/o/y fall was .8% vs the forecast of a drop of .2%. The overall price index fell for a 3rd month and is at the lowest since May. With politics being the main job growth story, Washington DC led the y/o/y gains followed by LA, San Diego and San Fran. California is a state with one of the biggest foreclosure rates over the past few years and with that, the faster the downward adjustment in prices, the quicker they bounce back as inventory is cleared. Maybe a lesson to be learned for other states. The other 16 cities saw y/o/y price declines led by Chicago, Atlanta, Detroit and Phoenix. Overall prices are now just 4.4% off its low in Apr ’09 and is 30% off its record high in July ’06. Bottom line, many assumptions of economic growth and the quality of bank balance sheets don’t assume a housing double dip and thus the recent trend bears watching.

Doug Kass is a leading markets commentator, and writes daily for RealMoney Silver.

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“Never make predictions, especially about the future.”
-Casey Stengel

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There are five lessons I have learned since my first surprise list for 2003:

1. how wrong conventional wisdom can be;

2. that uncertainty will persist;

3. to expect the unexpected;

4. that the occurrence of Black Swan events are growing in frequency; and

5. with rapidly changing conditions, investors can’t change the direction of the wind, but we can adjust our sails (and our portfolios) in an attempt to reach our destination of good investment returns.

Eight years ago, I set out and prepared a list of possible surprises for the coming year, taking a page out of the estimable Byron Wien’s playbook , who originally delivered his list while chief investment strategist at Morgan Stanley, then Pequot Capital Management and now at Blackstone. (Here was Byron Wien’s surprise list for 2010.)

Importantly, my surprises are not intended to be predictions but rather events that have a reasonable chance of occurring despite being at odds with the consensus.

I call these “possible improbable” events. In sports, betting my surprises would be called an “overlay,” a term commonly used when the odds on a proposition are in favor of the bettor rather than the house.
The real purpose of this endeavor is to consider positioning a portion of my portfolio in accordance with outlier events, with the potential for large payoffs.

Since the mid 1990s , the quality of Wall Street research has deteriorated in quantity and quality (due to competition for human capital at hedge funds, brokerage industry consolidation and former New York Attorney General Eliot Spitzer-initiated reforms) and remains, more than ever, maintenance-oriented, conventional and groupthink (or groupstink, as I prefer to call it). Mainstream and consensus expectations are just that, and in most cases, they are deeply embedded into today’s stock prices.

It has been said that if life was predictable, it would cease to be life, so if I succeed in making you think (and possibly position) for outlier events, then my endeavor has been worthwhile. My annual exercise recognizes that over the course of time, conventional wisdom is often wrong. As a society (and as investors), we are consistently bamboozled by appearance and consensus. Too often we are played as suckers as we just accept the trend, momentum and/or the superficial as certain truth without a shred of criticism. Just look at those who bought into the success of Enron, Saddam Hussein’s weapons of mass destruction, the heroic home-run production of steroid-laced Major League Baseball players Barry Bonds and Mark McGwire, the financial supermarket concept at what was once the largest money center bank (Citigroup (C)), the uninterrupted profit growth at Fannie Mae (FNM) and Freddie Mac (FRE), housing’s new paradigm of noncyclical growth and ever-rising home prices, the uncompromising principles of former New York Governor Eliot Spitzer, the morality of other politicians (e.g., John Edwards, John Ensign and Larry Craig), the consistency of Bernie Madoff’s investment returns (and those of other hucksters) and the clean-cut image of Tiger Woods.

In an excellent essay published over the past week, GMO’S James Montier makes note of the consistent weakness embodied in consensus forecasts.

Attempting to invest on the back of economic forecasts is an exercise in extreme folly, even in normal times. Economists are probably the one group who make astrologers look like professionals when it comes to telling the future. Even a cursory glance at Exhibit 4 reveals that economists are simply useless when it comes to forecasting. They have missed every recession in the last four decades! And it isn’t just growth that economists can’t forecast: it’s also inflation, bond yields, and pretty much everything else. If we add greater uncertainty, as refl ected by the distribution of the new normal, to the mix, then the difficulty of investing based upon economic forecasts is likely to be squared!

For 2011, consensus estimates for economic growth, corporate profits, stock price targets and interest rates are grouped in an extraordinarily tight range. I have chosen to use Goldman Sachs’ forecasts as a proxy for the consensus.

Here are Goldman Sachs’ principal views of expected economic growth, corporate profits, inflation, interest rates and stock market performance:

• 2011 GDP up 3.4% (global GDP up 4.7%);

• 2011 S&P 500 operating profits of $94 a share;

• year-end S&P 500 price target at 1,450 (a gain of about 15%);

• 2011 inflation of 0.5%; and

• the 2011 closing yield on the U.S.10-year Treasury note at 3.75%.

Looking beyond 2011, it appears that the consensus further expects that the domestic economy is well on its way toward delivering a smooth and self-sustaining and normal historical recovery that (from start to finish) should last about four years. The clustering of that consensus suggests that any short- or intermediate-term variant outcomes could be destabilizing to the markets, both to the upside and to the downside.

To some degree, my surprises for 2011 attack some of the similar, non-variant and nearly universally optimistic expectations on the part of money managers, strategists, economists and members of the fourth estate. As such, I want to emphasize that my intention is not to be a Cassandra or to be a contrarian for contrary’s sake but rather to recognize that most prefer the dreams of the future to the history of the past. My surprise list for 2011 recognizes an often repeated lesson of history: What seems easy for (bullish) investors to imagine today might prove more difficult to deliver, as prospect is often better than possession.

More than almost any time I can remember, there exists few variant views relative to consensus as we enter the New Year. Perhaps leading that minority is Gluskin Sheff’s David Rosenberg, who, though thoughtful and thorough in analysis, is pigeonholed by the media as a dogmatic standard-bearer for the bear case. (Gluskin Sheff’s David Rosenberg succinctly underscores and questions the universal optimism in his commentary this week.)

“Those who cannot remember the past are condemned to repeat it.”

-George Santayana

Looking at history, there was no better example of misplaced optimism than in the period leading up to the Great Decession of 2008-2009, providing a vivid reminder of the poor forecasting ability and investment risks associated with the crowd’s baseline expectations and the value of a surprise list that deviates from that consensus.

Only the remnants anticipated anything near the magnitude of the fall in the world’s economies and capital markets, despite what appeared to be clear and accumulating evidence of economic uncertainty and growing credit risks (and abuses). The analysis of multi-decade charts and economic series convinced most (along with other conclusions) that home prices were incapable of ever dropping, that derivatives and no-/low-document mortgage loans were safe, that there was no level of leverage (institutional and individual) too high and that rating agencies were responsible in their analysis. Importantly, they also failed to see the signposts of an imminent deterioration in business and consumer confidence that was to result in the deepest economic and credit crisis since the early 1930s.

From my perch, many of those who are now expressing the most extreme levels of optimism were the most wrong-footed two years ago and experienced not inconsequential pain in the last investment cycle. (Perhaps the recovery in equities was so swift in time and sizeable in magnitude that memories simply have been erased to the risks that are still omnipresent today.)

Back then and, to a lesser degree, today, many investors appear similar to victims of Plato’s allegory of the cave, a parable about the difficulty of people who exist in a world shaped by false perceptions to contemplate truths that contradict their beliefs. This is why so many investors were blindsided by the last downturn and, from my perch, continue to remain conditioned to wearing rose-colored glasses.

In the famous simile of the cave, Plato compares men to prisoners in a cave who are bound and can look in only one direction. They have a fire behind them and see on a wall the shadows of themselves and of objects behind them. Since they see nothing but the shadows, they regard those shadows as real and are not aware of the objects. Finally one of the prisoners escapes and comes from the cave into the light of the sun. For the first time, he sees real things and realizes that he had been deceived hitherto by the shadows. For the first time, he knows the truth and thinks only with sorrow of his long life in the darkness.

-Werner Heisenberg, Physics and Philosophy

Last year’s surprise list had relatively poor results. Only about 40% of my surprises were achieved in 2010, well under the success ratio in previous years. By means of background, about 50% of my 2009 surprises were realized, 60% in 2008, 50% in 2007, one-third in 2006 , one-fifth in 2005, 45% in 2004 and one-third came to pass in the first year of our surprises in 2003.

While my surprise list for 2010 hit on some of the important themes that dominated the investment and economic landscape this year, I failed to expect the announcement of further quantitative easing and did not accurately gauge investors’ animal spirits that followed the proclamation of QE2.

Here is a list of some of my meticulous surprises from last year’s list:

• Economy. Real GDP and corporate profit growth was, as I suggested, far better than expected during the first half of 2010, and my surprise that U.S. equities would weaken (and that P/E ratios would contract) despite that strength was accurate (in that stocks exhibited a negative return during that period).

• Housing and jobs. Despite the overall economic strength, both housing and employment failed to recover.

• Interest rates. My surprise that the yield on the 10-year U.S. note would fall under 3% by midyear and end 2010 at about 3% was prescient.

• SEC investigations. The broadening of the SEC’s assault on insider trading was a featured story in 2010.

• The Oracle of Omaha. Though Warren Buffett is still at the helm, our surprise that he would announce a possible successor was accurate.

• Hedge funds. Brilliant and legendary hedge-hogger Stanley Druckenmiller announced that he was leaving the investment business — in line with our surprise that a leading hedge-hogger would announce his retirement.

What follows is my list of 15 Surprises for 2011 — reduced from 20 surprises in previous year in order to be more on point. I have listed my surprises in four categories — economic (surprise Nos. 1-3), stock market (surprise Nos. 4-6), political (surprise Nos. 7-9) and general (surprise Nos. 10-15).

Click for Kass’ predictions

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Global Macro Monitor produces informed opinion about markets and the global economy. This was originally published on December 27, 2010.

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Professor Robert Shiller,  of Yale University,  is probably best known for his book, Irrational Exuberance, which called the top of the dot.com bubble and the second edition called the top in the housing market.  During our days on Wall Street, we were big fans of Shiller’s book,  Market Volatility.

We asked him once  to visit us in our offices and the meeting took place the day after then Fed Chairman Alan Greenspan’s famous Irrational Exuberance speech in December 1996,

But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?

The professor said he was in town to meet with Greenspan who was concerned about the run-up in stock prices.  During the meeting Greenspan solicited his thoughts on why stocks were rising.  The professor answered maybe it was just “irrational exuberance” among investors.  Hmmmm….

We think Shiller’s best work was Martket Volatility and specifically the following,

The Ambiguity of Stock Value

Stock prices are likely to be among the prices that are relatively vulnerable to purely social movements because there is no accepted theory by which to understand the worth of stocks….investors have no model or at best a very incomplete model of behavior of prices, dividend, or earnings, of speculative assets.

Shiller nails it here.  Stock values are ambiguous as there are no models to determine their “true” price. Even at the macroeconomic level this is true and Greenspan addressed it in his Irrational Exuberance speech,

There is, regrettably, no simple model of the American economy that can effectively explain the levels of output, employment, and inflation. In principle, there may be some unbelievably complex set of equations that does that. But we have not been able to find them, and do not believe anyone else has either.

Consequently, we are led, of necessity, to employ ad hoc partial models and intensive informative analysis to aid in evaluating economic developments and implementing policy. There is no alternative to this, though we continuously seek to enhance our knowledge to match the ever growing complexity of the world economy.

So to it is with our job in forecasting asset values, which can only be done with “ad hoc partial models” in the ether of ambiguity.   Because prices are determined by simple buying and selling, we paraphrase Shiller in constructing our ad hoc model,

Stock prices are likely to be among the prices that are relatively determined by capital flows because there is no accepted theory by which to understand the worth of stocks.

In our experience getting ahead of the capital flows has been more profitable than buying what we believe to be a “cheap” stock or selling an “expensive” stock.

And that leads us into the next issue of perspective based on reference points, time frames, and historical bias.

Take a look at the three objects.   Two charts of the exact same market, the S&P500 over different time horizons;   and one picture.

Do you see an S&P500 that is overvalued?  Undervalued?  Oversold? About to rollover or break to new highs?   Do you see a young lady or an old hag?  It most likely depends on your confirmation bias.     Larry Summers, who will leave the White House at the New Year,  coauthored a paper in the late 1980′s stating market volatility is caused by investors and traders with different time horizons.

But, like Keynes’ beauty contest analogy, the true question to ask for 2011 is not what we see, but what we believe the market – i.e., the dominant marginal buyers – will see.  Do they  see the young lady or the old hag?

Or maybe beauty is relative, or even ambiguous,  and we have to determine which markets will be deemed the least old or the most pretty.   And that just may be the best lesson here, which we think certainly is the case for the world’s major currencies.  Dollar strength doesn’t necessary equate to the young lady!

Posted on December 27, 2010 by macromon

Via VideoGum

Responding for a 2nd day to its Christmas day interest rate hike, the Shanghai index fell for the 9th day in the past 10, lower by 1.7% and is now near a 3 month low. The Hang Seng index, closed on Monday, fell almost 1% and also is near a 3 month low. China faces both a consumer price inflation problem and a property bubble and the action in their markets is clearly signaling doubt that a soft landing can be achieved. For the sake of global growth, fingers crossed that they do. Turning to currencies, while the focus of markets is usually DXY (dollar index) in gauging the strength or lack thereof for the US$, its missing $ weakness against other currencies because its heavily weighted to the Euro. The Swiss Franc is rising to a record high vs the US$, the CAD is back to parity and the AUD is now worth more than the US$. Also, the Taiwan $ is at a 13 yr high vs the US$ and the Yuan is a hair off its high.

These stats are from Thursday so sorry if you saw already but in case you missed it due to the holiday and weather, the AAII measure of individual investor sentiment was worth noting. Bulls rose 13 pts to 63.3, the highest since Nov 2004 while Bears fell 11 pts to 16.4, the lowest since Nov 2005.

Leading into the holiday period, the data — and by data, I refer to actual sales numbers, and not surveys, gut feelings or instincts — was strongly suggesting that the 2010 orgy of consumerism known as the holiday shopping season was likely to be stronger than expected.

The first clue I had of this was the Amazon sales from TBP. The embedded code of each link allows me to track click-throughs and purchases. All year long, it has been running significantly higher than 2009. (I’ll post some charts later this week).

Of course, plenty of people were stuck looking backwards. They gave tortured reasons as why this was not going to be a decent season. Call it a classic case of confirmation bias, these were the folks who simply refuse to acknowledge any improvements in the economy. These analysts seem to be shell shocked from the collapse; you should feel free to to do what you like, but once I recognize someone is caught in a negative loop, I tend to avoid their work until they prove they have some objectivity.

Why were the improved sales not a surprise to those people paying attention to the data? The negatives — weak job gains, housing overhang, consumer deleveraging, terrible municipal finances — were already well known all year. Even Oil over $90 was a not a big deal — it seems to have been in the $75-85 range for so long that gasoline over $3 had little shock value.

The newest data included more positives: Improving job market, equity gains, and an upcoming two percentage-point cut FICA payroll tax holiday in 2011. The 90.2% of the workforce that have jobs feel more secure (if they didn’t get laid off by now, they probably won’t). There is also a sense of widespread Recession fatigue; people are tired of living in bunkers, and are coming out to play again.

Lets consider the actual data, and what it might mean going forward:

• U.S. retailers’ 2010 holiday sales (excluding automobiles) jumped 5.5% — the best performance in five years, versus 4.1% in 2009 and down 6.1% in 2008

• Total holiday sales were $584 billion from Nov. 5 through Dec. 24, with notable increases starting as early as the second week of November

• Online seasonal sales up 15.4%; This is against an ongoing rise in online sales

• Apparel grew 11.2% over 2009 (-0.4%), with Menswear up 10.5%, and Women’s Apparel plus 5.6%

• Electronics lagged in dollar terms, growing 1.2% vs a 4.6% decline in 2009. Declining flat panel TV prices is a suspect

• Furniture sales were plus 3.8% vs minus 2.2% in 2009.

• Jewelry gained 8.4%

• Luxury (ex-Jewelry) grew 6.7% versus falling 0.9% last year.

Two last interesting datapoints worth mentioning:

Via the WSJ: 2010 consumer spending was 68.6% of the economy. This reflects an increase — yes, an increase –  from 66.5% in 2007. The reasons are 1) A sharp decrease in businesses spending; 2) The ongoing contraction of housing within the overall economy — currently at its lowest level since World War II.

Last, the US still has too large of a retail footprint — 40 square feet of retail space for each person; that is the most per person in the world. As I first noted in several speeches back in 2008, that needs to come down appreciably.

All told, a pleasant improvement over prior years . . .

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Previously:
Anecdotal Evidence: Shoppers Out in Full Force (November 21st, 2010)

Improving Holiday Sales Reflect Economic Recovery (November 29th, 2010)

Source:
SpendingPulse 2010 Holiday Wrap-Up Report
MasterCard Advisors’ SpendingPulse, December 27, 2010
http://www.mastercardadvisors.com/us/advisors/en/news_center/newsroom_detail.html?newsId=1323

Here are the latest additions to my Instapaper:

• Heads Up Play With David Einhorn (Dealbreaker)

• What we have here is one of the great comeback stories in the history of competitive punctuation: The Hash Mark (National Post)

• Transcript: The Assange interview (BBC)

• So you want to be a viral video? (Fortune)

• The Hazards of Nerd Supremacy: The Case of WikiLeaks (The Atlantic)

• The Physics of Terror (Miller-McCune)

• The Storming of St. Barth’s (Vanity Fair)

• ‘Damn right,’ I said: Eliot Weinberger’s brutal takedown of Decision Points by George W. Bush (London Review of Books)

• The 50 Best Albums of the Decade (Paste)

What are you reading ?

phewsha.tumblr.com:

tumblr via chart porn

The media likes to create lists, and around this time of year, we will see lots and lots of them. Biggest news stories, the years best gadgets, top grossing films.

Anyone with even a passing interest in reality should read these lists skeptically. Indeed, those of us who depend upon our understanding of objective (rather than subjective) reality understand that most people, institutions and especially the media, presents a very subjective view of the universe. I am not discussing bias, but rather, am making the philosophical point about subjectivity. Simply stated, it skews people world views to their own priorities and needs. This is why I emphasize selective perception so often.

Here is a fascinating thought experiment:

Consider what the leading causes of (non natural) deaths in the USA. Think about the television coverage, what you read in print, hear on radio, etc.

Based on the media coverage, you would assume it would go something like this: Terrorism, Homicide, Poisoned Food/drug supply, etc.

But it turns out that relative to the coverage, the reality is quite different.The media covers issues that are exciting, sensationalistic or have good visuals. This leads them to present a very different view of the world, one that does not conform very closely to reality.

For example: Automobiles are a far larger cause of death than homicides. The way deaths are portrayed on the news is hardly proportionate.

Dramatic television is even worse. CSI: Miami is far more exciting than CSI: Someone ran a red light and the ensuing accident left 2 injured, one dead. Yet auto deaths far outnumber homicides.

Even within accidental deaths, there are approximately twice as many Suicides as there are Homicides. Not that an American watcher of TV would ever know that. Murder, She Wrote has far more intrigue and drama, and is probably a whole lot more watchable, than “A painful incurable disease of an elderly person led to a suicide, She Wrote.”

The actual list of deaths in the USA is:

Motor Vehicle Traffic
Firearms
Poisoning
Falls
Suffocation
Act of War / Terrorism

Source: CDC Injury Data

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click for larger graphic

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The basic concept of this came from a quiz at Simple Complexity.