Blackstone Group’s Byron Wien

Top 10 surprises of 2010

Originally published in the February 2010 issue

Byron Wien, vice chairman, Blackstone Advisory Services, the Wall Street and hedge fund veteran, is respected for his canny reading of markets and economic developments. As has become custom, Wien recently issued his list of the Top 10 Surprises for 2010. This is the 25th year Wien has outlined his predictions of a number of economic, financial market and political surprises for the New Year.

The tradition took root in 1986 when he was the Chief US Investment Strategist at Morgan Stanley. Wien, now 76-years old, joined The Blackstone Group as a senior advisor in September 2009 from Pequot Capital where he had been chief investment strategist since 2005.

“The real problem on Wall Street is that there is too much incremental thinking and this tries to get away from that,” Wien says in an interview. With the forecasts, Wien says he looks for genuine surprises that fly in the face of the accepted consensus. He also aims to have a degree of consistency among the surprises even though this increases the risk that the forecast surprises could go badly wrong.

“I’ve learned a lot about when consensus thinking is bound to be wrong,” he says. For example, in 2008 one of his surprises was that Barack Obama would win handily and that the Democrats would take 60 Senate seats. Though Hillary Clinton led polls by 15 percentage points in January, 2008 Wien believed that Obama’s collar on the youth vote presaged an eventual shift among the electorate at large.
Reviewing Wien’s 2009 list shows that many of his forecasts were on the money. He foresaw a second-half recovery in the US economy and a sharp rise in the S&P 500, which ended 2009 up over 23%. His other correct predictions included gold hitting $1,200 an ounce and oil returning to $80 per barrel, while the ten-year US Treasury yield (which rose from 2.24% to 3.84%) marginally undershot Wien’s forecast of a rise to 4%.

At the beginning of 2009 he observed: “Later in the year, as the economy shows signs of recovery, economists and investors (will) shift their mood from concern about deflation to worries about inflation. A weak dollar, rapid growth in money supply and record-setting deficits (over $1 trillion) are behind the change.” Though the dollar didn’t fall to 1.65 to the euro it did get below 1.50 and it also fell against the yen as Wien had expected.

Wien may have been wide of the mark in suggesting that falling tax revenues from the financial sector would cause New York State to threaten bankruptcy, but his expectation that this would spread to other states has proven true with the state of California teetering on the edge of insolvency. And while the US Federal government hasn’t stepped in to bail out any states yet, it is still distinctly possible that such substantial assistance may yet be required.

Also mixed was Wien’s take on growth during 2009 in China. He correctly anticipated that growth would exceed 7% and that its stock market would revive on the back of the authoritarian government’s effectively executed stimulus policies. But his attribution of this to the Chinese consumer beginning to spend more and save less is a case that, at best, remains unproven.

In any given year, Wien says his ten surprises have at least a 50% chance of occurring at some point during the following 12 months. In 2009, that success rate looks to have been slightly higher. Thus the 2010 list provides an interesting opportunity for strategists and portfolio managers to test their own imaginations as well as engage in some ‘what if’ scenarios.

For 2010, Wien’s key financial conclusion is that US growth will surprise on the upside, helping to boost both the dollar and President Obama’s political fortunes in the mid-term elections. On markets, Wien is bullish about the impact a weakening yen and rising exports will have on Japanese mid-cap stocks. In the area of geo-politics, Wien expects a change of leadership in Iran and a further ratcheting up of political uncertainty in Pakistan.

Here are Wien’s 10 predictions for 2010:

1. The United States economy grows at a stronger than expected 5% real rate during the year and the unemployment level drops below 9%. Exports, inventory building and technology spending lead the way. Standard and Poor’s 500 operating earnings come in above $80.

2. The Federal Reserve decides the economy is strong enough for them to move away from zero interest rate policy. In a series of successive hikes beginning in the second quarter the Federal funds rate reaches 2% by year-end.

3. Heavy borrowing by the US Treasury and some reluctance by foreign central banks to keep buying notes and bonds drives the yield on the 10-year Treasury above 5.5%. Banks loan more to corporations and individuals and pull away from the carry trade, thereby reducing demand for Treasuries. Obama says, “The suits are finally listening.”

4. In a roller coaster year the Standard and Poor’s 500 rallies to 1,300 in the first half and then runs out of steam and declines to 1,000, ending where it started at 1115.10. Even though the economy is strong and earnings exceed expectations, rising interest rates and full valuations present a problem. Concern about longer term growth and obligations to reduce leverage at both the public and private level unsettle investors.

5. Because it is significantly undervalued on a purchasing power parity basis, the dollar rallies against the yen and the euro. It exceeds 100 on the yen and the euro drops below $1.30 as the long slide of the greenback is interrupted. Longer term prospects remain uncertain.

6. Japan stands out as the best performing major industrialized market in the world as its currency weakens and its exports improve. Investors focus on the attractive valuations of dozens of medium sized companies in a market selling at one quarter of its 1989 high. The Nikkei 225 rises above 12,000.

7. Believing he must be a leader in climate control initiatives, President Obama endorses legislation favorable for nuclear power development. Arguing that going nuclear is essential for the environment, will create jobs and reduce costs, Congress passes bills providing loans and subsidies for new plants, the first since 1979. Coal accounts for about 50% of electrical power generation, and Obama wants to reduce that to 25% by 2020.

8. The improvement in the US economy energizes the Obama administration. The White House undergoes some reorganization and regains its momentum. In the November Congressional election the Democrats only lose 20 seats, much less than expected.

9. When it finally passes, financial service legislation, like the health care bill, proves to be softer on the industry than originally feared. There is greater consumer protection, more transparency, tighter restriction of leverage and increased scrutiny of derivatives, but the regulatory changes for investment bankers and hedge funds are not onerous. Trading volume and merger activity increases; financial service stocks become exceptional performers in the US market.

10. Civil unrest in Iran reaches a crescendo. Ayatollah Khameini pushes out Mahmoud Ahmadinejad in favor of a more public relations adept leader. Economic improvement becomes the key issue and anti-Israel rhetoric subsides. Talks with the US and Europe begin but the country remains a nuclear threat. Pakistan becomes the hotspot in the region because of the weak government there, anti-American sentiment, active terrorist groups and concerns about the security of the country’s nuclear arsenal.