predicting the future year


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What’s neat about this isn’t what’s changed. It’s what’s stayed the same.

The line, “One million titles, consistently low prices” seems like marketing guff. But it helps explain why Amazon has dominated where others have failed.

The allure of the Internet in 1995 was betting on change. New paradigms born. Old strategies discarded. Something requiring radically different thinking.

Yet Amazon’s focus from day one was as old as it gets. Selection and price. Businesses have pursued the idea for millennia.

Jeff Bezos once explained why this was critical:

I very frequently get the question: “What’s going to change in the next 10 years?” That’s a very interesting question.

I almost never get the question: “What’s not going to change in the next 10 years?” And I submit to you that that second question is actually the more important of the two.

You can build a business strategy around the things that are stable in time. In our retail business, we know that customers want low prices, and I know that’s going to be true 10 years from now. They want fast delivery; they want vast selection. It’s impossible to imagine a future 10 years from now where a customer comes up and says, “Jeff I love Amazon, I just wish the prices were a little higher.” Or, “I love Amazon, I just wish you’d deliver a little slower.” Impossible.

So we know the energy we put into these things today will still be paying off dividends for our customers 10 years from now. When you have something that you know is true, even over the long term, you can afford to put a lot of energy into it.

This is one of those important things that’s too basic for most smart people to pay attention to.

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Things that change are amazing. They can fuel massive growth.

But change by itself is hard. Investors have to spot it before it’s obvious. Consumers have to change their behaviors to make it viable. Those two points repel each other like magnets. And things that change tend to keep changing. A company whose pitch is “We’re doing this entirely new thing” likely has to reinvent itself and its product line every year, maybe more. Each iteration is a front-line battle where you’re exhausted from the last war but overconfident from its victory. So the odds keep stacking against you. An investor hoping to ride successive changes in multiple industries over a 40-year career faces tenth-degree difficulty. Practically a claim of clairvoyance.

Change often creates bursts of opportunity. Huge opportunity, yes. But businesses and their investors need more than slippery bursts to succeed. They need endurance. And endurance resides in long-term bets. Things you can pour energy and capital into today with a reasonable chance of still bearing fruit ten years from now. Which tend to be things that are stable in time.

This might seem heretical to venture capital. Marc Andreessen was once asked how his investment style compared with Warren Buffett. He replied:

[Warren is] betting against change. We’re betting for change. When he makes a mistake, it’s because something changes that he didn’t expect. When we make a mistake, it’s because something doesn’t change that we thought would. We could not be more different in that way.

Seems directionally true. But I don’t think it’s that black and white. Both investors pursue the same things; they just weight them differently.

Every successful investment is some combination of change that drives competition and things staying the same that drives compounding. There are so few exceptions to this, regardless of size or industry.

Buffett has owned GEICO stock since 1951. During that time the company went from exclusively selling auto insurance to government employees in cafeterias, to selling several kinds of insurance to everyone on their iPhones. Analytics went from abacus to AI. These are not small changes. But one thing stayed the same, which is that an insurance company selling directly would have a cost and convenience advantage over those paying brokers. That’s been the driver of Buffett’s GEICO bet for 66 years. It’s timeless.

Andreessen Horowitz partner Frank Chen recently talked about two trends in insurance startups. One is better software. “Software will rewrite the entire way we buy and experience our insurance products,” he said. Second is capital structure. “We expect to see more crowdsourced insurance companies … it should be a cheaper way to pool capital.” Both innovations promise lower cost and added convenience. Which is as timeless as GEICO’s edge.

Investors weigh the importance of change and timelessness differently, but every great company has some element of both. The extremes are where things don’t work.

Take three companies in the 1990s: Sears, Beenz, and Amazon.

Sears bet the Internet changed nothing, to its detriment. Beenz bet the Internet changed everything – creating a points-based currency valid only at online merchants – to its detriment. Amazon bet the Internet changed distribution, but rooted its strategy in things that have never, and will never, change. It nailed the center of the Venn diagram of change on one side and timeless on the other. One drove competition, the other drove compounding. Every successful company does this.

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In the last 100 years we’ve gone from horses to jets and mailing letters to Skype. But every sustainable business is accompanied by one of a handful of timeless strategies:

  • Lower prices.
  • Faster solutions to problems.
  • Greater control over your time.
  • More choices.
  • Added comfort.
  • Entertainment/curiosity.
  • Deeper human interactions.
  • Greater transparency.
  • Less collateral damage.
  • Higher social status.
  • Increased confidence/trust.

You can make big, long-term bets on these things, because there’s no chance people will stop caring about them in the future.

 

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Speaking in London, Federal Reserve chair Janet Yellen Tuesday predicted that the “the system is much safer and much sounder” and explained that the Federal Reserve is prepared to deal with numerous enormous shocks to the economy.

In her conversation with Lord Nicholas Stern, Yellen also went on to list the reasons that, thanks to central bank intervention, there is unlikely to be another financial crisis “in our lifetimes.”

For those who have lived through more than one business cycle, however, alarm bells tend to go off every time an economist, central banker or high-ranking government official declares that there’s little to no danger of economic turmoil in the near future.

There is a long history of spectacularly bad predictions being made shortly before economic crises. Famously, shortly before the Crash of 1929 — one of the earlier crises that occurred on the Federal Reserve’s watch — Herbert Hoover proclaimed that “We in America today are nearer to the final triumph over poverty than ever before in the history of any land.”

But, we certainly don’t have to go back that far.

Indeed, in the late 1990s, it became nearly routine to hear economists announce that “the internet changes everything” and “the business cycle is dead.”

Economist Rudi Dornbusch — a close associate of current Fed vice chair Stanley Fischer — even wrote a July 1998 column in the Wall Street Journal titled “Growth Forever.” Dornbusch concluded that the possibility of an imminent recession “is remote” and the country “will not see a recession for years to come.” So sure of the benefits of the “new economy” was Dornbusch, in fact, that he declared, “This expansion will run forever.”

Then came the dot-com bust of 2001. After that came a short expansion from 2002 to 2007. After that came the Great Recession.

Meanwhile, from 2000 to 2015, according to the federal government’s data, real median household income was flat. Only over the past two years have we seen any of that expansion that many were venturing to say was permanent back in the late 1990s.

Economists and policymakers were no more insightful when examining the possibility of a new crisis post-2007.

In 2005, for example, Milton Friedman could have been paraphrasing Yellen’s Tuesday comments when he concluded that “the stability of the economy is greater than it has ever been in our history. We really are in remarkable shape.” Friedman went on to give Alan Greenspan credit for the expansion.

In early 2007, Ben Bernanke predicted, “We’ll see some strengthening in the economy sometime during the middle of the new year.”

As late of mid-2007, Bernanke was downplaying any problems associated with the sub-prime housing market, allaying any fears of a bubble or bust and claiming, “I don’t know whether prices are exactly where they should be, but I think it’s fair to say that much of what’s happened [i.e, enormous home price growth during the housing bubble] is supported by the strength of the economy.”

If housing bubbles do prove to be a problem, Bernanke concluded, it’s “mostly a localized problem and not something that’s going to affect the national economy.”

The US would officially begin to contract in December 2007, followed by a financial crisis the following autumn.

Even on the eve of the crisis — in September 2008 — John McCain announced that “the fundamentals of our economy are strong.”

A year later, the unemployment rate would reach 10 percent, foreclosure rates were surging and total employment would collapse from 116 million to 107 million. Employment would not return to pre-crisis levels until late 2013.

Millions of workers would need to change careers, be retrained, scratch for other forms of income to avoid foreclosure or eviction and put off retirement indefinitely. The economy was so weak for so long, in fact, that the Fed felt it necessary to keep the key target interest rate near zero for seven years to add “stimulus.”

Of course, just because Janet Yellen says the economy won’t experience a crisis anytime soon doesn’t mean a crisis is imminent. A truly strong economy isn’t going to be “jinxed” by a declaration that things are fine. On the other hand, given the record of eminent economists and Fed board members in the past, Yellen’s predictions are hardly anything that should inspire confidence.

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Now here are The Ten Surprises of 2017. I will discuss them in detail in my February essay.

1. Still brooding about his loss of the popular vote, Donald Trump vows to win over those who oppose him by 2020. He moves away from his more extreme positions on virtually all issues to the dismay of some right wing loyalists. He insists, “The voters elected me, not some ideology.” His unilateral actions throw policy staffers throughout the government into turmoil. Virtually all of the treaties and agreements he vowed to tear up on his first day in office are modified, not trashed. His wastebasket remains empty.

2. The combination of tax cuts on corporations and individuals, more constructive trade agreements, dismantling regulation of financial and energy companies, and infrastructure tax incentives pushes the 2017 real growth rate above 3% for the U.S. economy. Productivity improves for the first time since 2014.

3. The Standard & Poor’s 500 operating earnings are $130 in 2017 and the index rises to 2500 as investors become convinced the U.S. economy is back on a long-term growth path. Fears about a ballooning budget deficit are kept in the background. Will dynamic scoring reducing the budget deficit actually kick in?

4. Macro investors make a killing on currency fluctuations. The Japanese yen goes to 130 against the dollar, stimulating exports there. As Brexit moves closer, the British pound declines to 1.10 against the dollar, causing a surge in tourism and speculation in real estate. The euro drops below par against the dollar.

5. Increased economic growth, inflation moving toward 3%, and renewed demand for capital push interest rates higher across the board. The 10-year U.S. Treasury yield approaches 4%.

6. Populism spreads over Europe affecting the elections in France and Germany. Angela Merkel loses the vote in October. Across Europe the electorate questions the usefulness of the European Union and, by the end of the year, plans are actively discussed to close it down, abandon the euro and return to their national currencies.

7. Reducing regulations in the energy industry leads to a surge in production in the United States. Iran and Iraq also step up their output. The increased supply keeps the price of West Texas Intermediate below $60 for most of the year in spite of increased world demand.

8. Donald Trump realizes he has been all wrong about China. Its currency is overvalued, not undervalued, and depreciates to eight to the dollar. Its economy flourishes on consumer spending on goods produced at home and greater exports. Trump avoids punitive tariffs to prevent a trade war and develops a more cooperative relationship with the world’s second largest economy.

9. Benefiting from stronger growth in China and the United States, real growth in Japan exceeds 2% for the first time in decades and its stock market leads other developed countries in appreciation for the year.

10. The Middle East cools down. Donald Trump and his Secretary of State Rex Tillerson, working with Vladimir Putin, finally negotiate a lasting ceasefire in Syria. ISIS diminishes significantly as a Middle East threat. Bashar al-Assad remains in power.

ALSO RANS

Every year there are always a few Surprises that do not make the Ten either because I do not think they are as relevant as those on the basic list or I am not comfortable with the idea that they are “probable.”

11. Having grown weary of Washington after a year in the presidency, Donald Trump moves the White House to New York from April to December and to Palm Beach from January to March. He makes day trips to the Capitol on Air Force One for legislative and diplomatic purposes.

12. The Democratic Party is sharply divided on strategy, with Bernie Sanders and Elizabeth Warren arguing for a shift to the left and others wanting to remain in the center. A lack of leadership gives rise to widespread speculation about sharp losses in the 2018 congressional elections.

13. Donald Trump’s intimidation tactics prove effective in discouraging companies from moving some U.S. manufacturing abroad, but he fails to bring jobs back. The wage differential is just too great. This becomes his biggest first-year disappointment.

14. Trump’s first major international confrontation comes, not unexpectedly, from North Korea. Kim Jong-un threatens to set off a nuclear bomb in the mid-Pacific, calling it “a test.” Trump’s advisors try to restrain his desire to punish the country severely.

15. India comes back into the investment limelight. Its economy grows at 7% and corporate profits for established companies are strong. Its stock market leads other large emerging countries, along with China.

16. Trump’s efforts to get out of the Iran deal fail. The other countries signing the agreement believe Iran’s weapons-grade nuclear production has been restrained and force the U.S. to remain a participant.

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One of the things I failed to learn after writing a book was the simple fact that methodically demonstrating a thing with data and evidence doesn’t resolve that issue. I shouldn’t have been so naive, given that some people still are flat-earthers, or are anti-vaxxers, or Holocaust deniers, or claim that global warming is a Chinese hoax.

Which is why, despite all of the earlier discussions about the folly of forecasts, I find myself once again compelled to bring up this subject. Blame it on the time of year, when all of the forecasts for 2017 are being rolled out, while the old ones that were so-often wrong are forgotten instead of being reviewed.

So please consider this column a public service. Here is a round-up of some of 2016’s forecasts, and a look at why they didn’t quite work out as expected:

• Get Ready for $80 Oil: “When oil drilling activity collapses, oil supply goes down too.” That may or may not be true, but one thing we know is that oil never got anywhere near $80 this year, peaking at about $53 earlier this week. The error here is assuming you can: Accurately measure a drilling activity slowdown; figure out what that impact will be on supply; and determine how that will affect prices. This forecast, made by Raymond James, tried to thread that needle. It didn’t happen.

• The recession of 2016: “Central bank bungles, oil price fluctuations and overregulation indicate contraction.” This forecast, published in the reliably ideological Washington Times, commits the classic analytical error of infusing emotional politics into forecasts. The author opposed the Federal Reserve’s program of quantitative easing as well as government regulations, so of course these things will cause a recession! Only, they didn’t. Economic analysis colored by political bias equals awful investing advice.

• Recession sign is in play and has 81% accuracy: Recessions have followed consecutive quarters of corporate earnings declines (whenever that happens) four out of five times, according to JPMorgan Chase & Co. strategists. There are at least two reasons for this: First, as we have discussed before, relying on a single variable to explain a complex system such as the economy is a poor approach to analysis. The world is just not black and white. Second, it confuses correlation with causation.

• Billionaire Sam Zell Says Recession Likely in Next 12 Months: This one blames the Fed and the strong dollar, which fell in the six months after Zell’s prediction. We have discussed Zell’s call before, but a few words about the halo effect, or the tendency to give people successful in one field more credibility than is warranted in other areas. Although we have to give credit to a billionaires’ ability to make money, they probably don’t have a comparable ability to foretell recessions.

• Why Gold Will See $2,000: Gold bugs are too easy to debunk. But as a reminder, the market has managed to figure out that China and India are net buyers of gold, and have been for thousands of years. That isn’t what is going to drive its price, which never reached more than about $1,375 this year.

Debate Night Message: The Markets Are Afraid of Donald Trump: “Wall Street fears a Trump presidency. Stocks may lose 10 to 12 percent of their value if he wins the November election, and there may be a broader economic downturn.” So wrote Justin Wolfers in the New York Times on Sept. 30, based on a “close analysis of financial markets during Monday’s presidential debate.” This looks like another classic error of causation and correlation. This prediction, for all we know, may yet prove true. But we have to note that since the election, the Standard & Poor’s 500 Index is up 6 percent.

• This Dow rally will end March 23: This forecast was made on Feb. 16, so at least it didn’t have much shelf life. Studies have shown that people prefer false precision to accurate ambiguity. The forecaster who tells you that the future is inherently unknowable, and all forecasts 12 months out are just guesses isn’t as well received as someone saying with certainty that the Dow Jones Industrial Average will top 21,000 on the day Donald Trump is inaugurated as president. Why don’t investors recognize this? The answer is quite simple: It is just human nature.

Those who make forecasts for a living, or are asked to do so by the news media, should use the opportunity when they make a prediction to point out the absurdity of the exercise. My own 2017 predictionsattempt to do just that.

The bottom line remains: forecasts and predictions are exercises in marketing. Outrageous and wrong forecasts are typically forgotten, and when one randomly happens to come true, the guru is lauded as the next Nostradamus. It is an expensive and fatuous practice, and the finance industry should give it a permanent rest.

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Ray Kurzweil, the author, inventor, computer scientist, futurist and Google employee, was the featured keynote speaker Thursday afternoon at Postback, the annual conference presented by Seattle mobile marketing company Tune. His topic was the future of mobile technology. In Kurzweil’s world, however, that doesn’t just mean the future of smartphones — it means the future of humanity.

Continue reading for a few highlights from his talk.

On the effect of the modern information era: People think the world’s getting worse, and we see that on the left and the right, and we see that in other countries. People think the world is getting worse. … That’s the perception. What’s actually happening is our information about what’s wrong in the world is getting better. A century ago, there would be a battle that wiped out the next village, you’d never even hear about it. Now there’s an incident halfway around the globe and we not only hear about it, we experience it.

Which is why the perception that someone like Trump sells, could be false and misleading. But more importantly, what actions we take based upon that information. If I respond differently, then my perception has directly changed my actions, which has unforseen ramifications when multiplied by millions.

Brexit could be an example of exactly this.

On the potential of human genomics: It’s not just collecting what is basically the object code of life that is expanding exponentially. Our ability to understand it, to reverse-engineer it, to simulate it, and most importantly to reprogram this outdated software is also expanding exponentially. Genes are software programs. It’s not a metaphor. They are sequences of data. But they evolved many years ago, many tens of thousands of years ago, when conditions were different.

Clearly our genome is not exactly the same. It to has evolved. This may have been through random mutations, in which certain recipients thrived in a changing environment.

How technology will change humanity’s geographic needs: We’re only crowded because we’ve crowded ourselves into cities. Try taking a train trip across the United States, or Europe or Asia or anywhere in the world. Ninety-nine percent of the land is not used. Now, we don’t want to use it because you don’t want to be out in the boondocks if you don’t have people to work and play with. That’s already changing now that we have some level of virtual communication. We can have workgroups that are spread out. … But ultimately, we’ll have full-immersion virtual reality from within the nervous system, augmented reality.

One of my favorite novels is Asimov’s “Foundation” series. The planet Trantor….entirely covered by a city. Is that what we want?

On connecting the brain directly to the cloud: We don’t yet have brain extenders directly from our brain. We do have brain extenders indirectly. I mean this (holds up his smartphone) is a brain extender. … Ultimately we’ll put them directly in our brains. But not just to do search and language translation and other types of things we do now with mobile apps, but to actually extend the very scope of our brain.

The mobile phone as a brain extender. Possibly true for 1% of all users. Most use facebook or whatever other time wasting application, and essentially gossip. A monumental waste of time. Far from being a brain extender, for most, it is the ultimate dumbing down machine. Text language encourages bad spelling, poor grammar etc. So you can keep your brain extenders.

As far as directly connecting your brain to the cloud….that sounds like ‘The Matrix”, which is of course the subject of philosophical musings about the brain in a vat. The potential for mind control would seem to be a possibility here. Not for me thanks.

Why machines won’t displace humans: We’re going to merge with them, we’re going to make ourselves smarter. We’re already doing that. These mobile devices make us smarter. We’re routinely doing things we couldn’t possibly do without these brain extenders.

To date, I would argue that the vast majority are significantly more stupid because of them.

As to robots and AI, imagine a man, Spock, who’s choice making is driven 100% by logic, rather than by 50% logic and 50% emotion. How long does the emotional decision maker last? Most emotional decisions get us in trouble. The market is an excellent example. Politics is another, ie. Trump.

 

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The bear case rests on two major Federal Reserve policies: [i] the [gradual] withdrawal of QE and [ii] the continuance of ZIRP. If either one is reversed, the stock market reverses.

There is however the interest rate curve to consider, other than the short end which is controlled by the Federal Reserve.

10yr

The 10yr has bottomed. It has also started what looks like a new trend higher. This is in large part because the Fed switched its QE purchases away from the 10yr and back to MBS securities [to hold mortgages lower] and the banks’ balance sheets.

In the short term, a very indefinite period of time, I don’t believe that a rising interest rate effects stocks in a negative manner. After all buying against the trend of rising yields, costs you money. Also currently the real return is far lower, thus stocks, which appreciate nominally, continue to benefit.

At some point though this changes. At some point the relative risk of the so called risk-free return outweighs the nominal [or real] returns on holding stocks. At that point, we see a rotation out of stocks back into Treasuries. Will that point be reached in 2014? I don’t think so, but, watch it nonetheless.

Margin Debt.

Margin debt suddenly started to be discussed again within the last two weeks. Margin creates leverage. High leverage that remains unhedged, creates higher volatility. Higher volatility creates a higher perceived risk. Both of these combine into shortening the ability to hold investments, and magnify losses to the position. That margin debt is again at or near all-time highs argues for an increase in volatility. Data here

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Sentiment.

dumb money

Sentiment is also driven via the media. Whether that be the traditional media or the newer blogoland. All forms of sentiment tend to conform to the current trend. When at extremes, also tend to be wrong.

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Let me start with this last year’s stock market. Retrospectively in a few years the refrain will likely be, oh, that was an easy market it only went up. Because [pretty much] it only went up, it has been a very difficult market to stay long in [lots of Hedge Funds couldn’t or didn’t] and underperformed.

parabola

So of course the question is: does this bull market continue? The answer at least from this chap is:

parabola collaspe

This is based on empirical data, a true statement. It is likely to be true at some point in the future also. The question again is, assuming that it is true, when? That of course is the question that no-one can actually answer although many will try.

One approach is to elucidate the variables that actually created the bull market from March 2009 through to today. Clearly QE must be on the list.

9-7-12-QE-Chart-SP

Also something that should be considered is that in a period of consolidation, the breakout, if it occurs, is substantial and sustained. As can be seen, the consolidation was significant and the breakout higher [for whatever reason] could run a lot farther than many might expect.

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Another argument for the continuation is that current valuations are not in that turnaround zone, the P/E still below 20 at 18.

crestmontbull

Sentiment fluctuates. Until recently however we have had a number of perma-bears. Some quite recently have flippe-flopped, but there are still enough out there to give the bull some legs.

eeyore

Interest rates at the short end are going to be held low. This means ongoing credit creation.

3mth

Unemployment remains high. This will allow the Federal Reserve to hold QE for longer, and also maintain the low interest rates until the inflation even on the manipulated CPI ratchets too high. However for the moment unemployment will not make any meaningful improvements.

Inflation also remains according to the manipulated CPI ‘low’. Clearly this is false, however until the mainstream start to shout fire, the general perception is that inflation is low will remain.

In summary, these have been the primary drivers of the surge in the stock market. Should they all remain, then there is no reason why the market cannot move higher in 2014.

I will look at the bear case in part II

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