Authored by Sven Henrich via NorthmanTrader.com,
Let’s have some fun with predictions shall we? I even brought my crystal ball and magic sparkly chest hair ready to muse about the known unknowns and unknown unknowns.
What are those?
Here’s a primer:
“There are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns – the ones we don’t know we don’t know.” – Donald Rumsfeld
Well there ya go.
Markets have been pricing in perfection as we see the most overbought readings in history unfolding with along with the investor sentiment to match. For years markets have also ignored every potential bad news that came along. Brexit? Bought. Ebola? Bought. NK missiles? Bought. Oh I could go on, there are dozens of examples.
So perhaps it may be pointless to even point out potential risks for a market that sees no risk. But even the events that were bought brought about sudden and deep downside. After all who can forget US futures lock limit down during the US election?
So below is my top 5 list (by no means all) of potential US events/developments that may shake things up in 2018.
Known Unknowns
1. New Fed Chair
We know we have a new Fed Chair coming in February. Jerome Powell will take over the helm for Janet Yellen. What’s the track record for markets with the advent of a new Fed Chairperson? Let’s say more volatile than the past year:
Greenspan came in the summer of 1987 and we had the infamous 1987 crash just a few months later. Ben Bernanke came into office in 2006 and famously proclaimed the housing market was fine. We know what happened. When Janet Yellen took over in 2014 markets immediately dropped nearly 7% and had another set of corrections in 2014/2015 and 2016. Since then: No more corrections. Correlation is not causation, but it’s a factor to consider as the Fed struggles with their rate hike schedule. We know new Fed chairs have found themselves dealing with corrections and even crashes as markets perhaps test the new Fed Chair. What is unknown is the when, but history suggests the new Fed Chair will have some market turbulence to deal with during his first year in office.
2. Rising Rates
We know rates are rising. And we know consumers, corporations and the US government are all more levered into debt than ever before. When will raising rates meet a point of what I described as the moment of singularity? Perhaps negative effects on stocks may come sooner than most anticipate as some company ratings are already getting impacted as an alternative for yield is emerging. As of today the 10 year is rising above 2.6%. Gundlach’s key numbers is 2.63%. We’re getting close. Prediction: Markets will experience a moment of yield angst in 2018.
3. Mueller
We know Mueller’s investigation continues independently of what anyone’s opinion or conviction may be on the matter. None of it has mattered to markets so far despite several indictments and/or convictions. However Mueller keeps adding to his team and digging deep into financial records. Some may call it a witch hunt, but, as history shows, words have little relation to the end result:
Markets reacted very negatively to the ensuing developments in 1973/1974. Risk is that more high profile indictments will ensue. Even Steve Bannon has been subpoenaed by Mueller who keeps expanding the reach of the investigation. An unprecedented constitutional crisis could unfold should the indictment chain extend to Trump’s immediate family. When push came to shove Nixon resigned. I would expect Trump to react differently. Kicking, screaming and tweeting. Prediction: A Mueller surprise will catch the market’s attention.
4. US mid-terms
Mid terms are not until November, but political positioning can change way ahead of time and political fortunes can be notoriously fickle especially as the sugar rush of high optimism can lead to a sour taste. This is true for all political sides. In this case, however, we’re dealing with a president that never has managed to get a plurality in popular support despite record market highs and cycle lows in unemployment. His base however remains very steady mainly driven by a firm belief that he is looking out for their interest and is draining the swamp. Will reality sink in and cause the base to abandon him? Some rumblings are already being heard and the beneficiaries of tax cuts don’t look like the base. They are insurance companies, bankers, etc and their executives. A shift in base support in conjunction with a surprise in the Mueller investigation may prompt the GOP to turn on Trump. Markets don’t like uncertainty nor a political crisis. Prediction: Tax cut jubilance will lead to tax cut hangover. The resulting political uncertainty will spill over to markets.
5. Earnings
We know tax cuts have prompted Wall Street to raise earnings and buyback forecasts dramatically for 2018. Expectations are high and leave little room for error and the macro data contains enough concerns that the organic earnings picture (not the tax cut driven one) may disappoint. Already we see companies such as $GE, $C, $GS and others react negatively to their earnings results despite tax cuts factored in. $AAPL announced very impressive numbers & has seen its stock react positively so far consistent with upper technical target zone I outlined. Risk however is that many individual issues can’t meet the lofty expectations now priced in.
Here’s the chart of Boeing, an industrial company and $DJIA component with 1.7% in quarterly revenue growth, 7.3% profit margin, returning 6.3% on assets, and trading 193 times above book value with a PEG ratio of 2.02 & forward P/E of 29.82
Optimism priced in? Priced to perfection? You tell me. Prediction: Key stocks will not be able to meet the lofty expectation set and will disappoint and, given their historic price stretches, are at risk of steep technical reconnects.
Unknown Unknowns
It is charts like the one above that may make one muse about the unknown unknowns. By definition they are completely unpredictable and it is often a spark or event that nobody foresaw in advance that yields horrific results. And in some cases there’s no obvious cause or trigger other than a sudden shift in orientation.
In the past such triggers have come on the heels of extended markets gains and extremely high levels of optimism. As I said before: Check the Rhyme.
If a picture is a thousand words then I think it’s fair to say that optimism is extremely high:
Best hope that an unknown unknown doesn’t turn KA-DOW into KA-PUTT.
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