Kass’ Korner

I’m the president of Seabreeze Partners Management and write Doug’s Daily Diary for TheStreet's Real Money Pro. Stop by here for trading ideas, analysis on the stock market and the economy and the occasional song parody!

[dougkass]

A Year of Surprises Lies Ahead

"Engage people with what they expect; it is what they are able to discern and confirms their projections. It settles them into predictable patterns of response, occupying their minds while you wait for the extraordinary moment -- that which they cannot anticipate." -- Sun Tzu, The Art of War

I followed my game plan Monday of embracing volatility (long and short) and moved rather dramatically from a large net-long position to a net-short one.

I continue to believe that 2016 will be a year of surprises and drama -- politically, economically and market-wise:

Politics. This year began with one of the most "probable improbables" -- controversial, outspoken Republican Donald Trump leading the pack of GOP presidential contenders. (Sarah Palin even reappeared to endorse him.) And last night, we saw a shocking development in the Democratic presidential contest as non-Democrat Bernie Sanders wound up in a dead heat at the Iowa caucuses with leading contender Hillary Clinton. On the Republican side, one-time GOP heir apparent Jeb Bush spent $4,000 for each vote he got in Iowa. You can't make this stuff up.

Economics. The inability of zero interest rates, $30-a-barrel oil and injections of liquidity to catalyze global economic growth has led to negative interest rates in some regions and countries. After the Bank of Japan cut its benchmark rate below zero last week, yields on more than $7.1 trillion of government debt have turned negative. Meanwhile, yields on U.S. investment-grade and junk bonds are rising to their highest levels in four years. (I think U.S. credit is attractive and underpriced.)

Markets. Short-term moves are often exaggerated in our current backdrop of machine-dominated markets. They're full of sound and fury, but provide an uncertain setting for the buy-and-hold crowd and arguably diminish some of charting's value. But they provide a wonderful opening for opportunistic traders willing to buy or short the market's extremes. Importantly, the "contrary" -- an up move in the last 10 days within the context of a down market -- recently prevailed as the market put what the benefit of hindsight shows was probably a capitulation low.

"A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty." -- Winston Churchill

I made an about-face 10 days ago and turned near-term bullish while maintaining a bearish intermediate-term view. I based that on the extreme swings I was seeing in many sentiment indicators. (My RealMoneyPro colleague James "RevShark" DePorre writes intelligently in his opening missiveTuesday about the role -- both pro and con -- of contra-trend trading.)

Just when some of the bulls became more cautious as the market broke down hard in mid-January, the S&P 500 rallied by 7% between Jan. 20's "noon swoon" and last Friday's close.

There were numerous technical and sentiment indicators that served as a signpost of opportunity 10 days ago. But unfortunately, as I noted in yesterday's column Get It While You Can ... As We Need It Now, the 7% rally might be about all we can expect. We seem to be resuming a downtrend of lower stock prices and deteriorating fundamental and technical conditions. (Helene "The Divine Ms. M" Meisler argues this morning how quickly we've moved from an oversold condition to a developing overbought one.) 

Speaking of technicals, I've been having a spirited debate recently with Real Money Pro colleagues RevShark, Tim Collins and others on the merits of technical vs. fundamental analysis.

This reminds me of a great joke told I heard last night at a small dinner party at Ira Harris' house. Home Depot founder Ken Langone, Omega's Lee Cooperman and Sanford C. Bernstein founder Roger Hertog and others were there to celebrate 82-year-old Byron Wien.

Here's the joke:

A technical analyst and a fundamental analyst are chatting about the markets in the kitchen.

One of them accidentally knocks a kitchen knife off of the table, and it lands right in the fundamental analyst's foot.

The fundamental analyst yells at the technician, asking him why he didn't catch the knife.

"You know technicians don't catch falling knives!" the technician responded.

He, in turn, asks the fundamental analyst why he didn't move his foot out of the way.

The fundamental analyst responds: 'I didn't think it could go that low!"

Baby, It's (About to Be) Cold Outside

"I got to get home (But baby, you'd freeze out there) Say, lend me a coat. (It's up to your knees out there) You've really been grand (I thrill when you touch my hand) But don't you see? (How can you do this thing to me?)"

-- Frank Loesser, Baby It's Cold Outside

I've consistently expressed my intermediate-term bearishness over the last 15 months on technical and fundamental grounds, while in the process parodying:

Dr. Seuss (in The Bull in the Hat and Green Eggs and Stocks: Neither Rocks)

Janis Joplin and Hillary Scott (of Lady Antebellum)

Cheech and Chong

Frank Loesser

The movie Trading Places

But regardless of what investment methodologies we use (or what parodies I offer up), 2016 promises to be a year filled with surprises.

I outlined my 15 Surprises for 2016. Possible surprises that I see range from socialist Bernie Sanders becoming the Democratic presidential nominee to a deepening bear market caused by a garden-variety recession. (I even think Pete Rose might end up in the Baseball Hall of Fame!)

We'd all like to see the market's future with clarity. But we're living in extraordinary, abnormal times (i.e. negative real interest rates) where the only certainty around is the lack of certainty.

Enjoy, endure, capitalize upon and survive each surprise as it comes to you (if it does). It's said that surprises are the greatest gift that life can grant us. Prepare to be shocked and embrace surprises -- and the opportunities that they present.

The Bottom Line

"Remember, the storm is a good opportunity for the pine and the cypress to show their strength and their stability." -- Ho Chi Minh

Whether you're a fundamental or technical practitioner, buckle up and err on the side of conservatism in what's expected to be a volatile and surprising 2016 (with potentially stormy conditions).

After all, baby it's about to get cold outside -- figuratively and literally!

[dougkass]

The Past, Present and Future

"Disasters have a way of not happening."

-- Byron Wien, The Blackstone Group

If optimism is the enemy of the rational buyer, then pessimism is his or her ally. Personally, I'm growing more constructive over the near term thanks to lower stock prices.

The Shanghai stock market fell by another 6% to its lowest level in more than a year. Oil also dropped below $30 but rallied back as of last check, while the S&P 500 futures were down by about 15 handles earlier but are now virtually unchanged.

The Present: A Flat and Interconnected World

Looking more broadly, the BRICs -- Brazil, Russia, India and especially China -- continue to export slower economic activity, lower corporate profits and deflation (especially of the "lower-oil" kind).

Many of business TV's "talking heads" grossly underestimated and dismissed this theme throughout 2015, but often continue to be invited guests and maintain their "sound-byte" platforms.

But pride goeth before fall, and common sense and logic always trump investment dogma. I recommend investors do their own homework and consider outlier events (or what I call "possible improbables" in my annual "surprises" list.)

I remain short on Chinese stocks, and the iShares China Large-Cap ETF (FXI) remains on my "Best Short Ideas" list. I've consistently warned about China, and one of my primary intermediate-market concerns surrounds the region, which has been an engine of global growth.

There's upwards of $5 trillion of U.S.-dollar-denominated debt around the world, which raises concerns that debt service will grow more difficult. Dismissing the difficulties surrounding China's economic transition and debt overload in the Asian nation's public sector, banking and shadow-banking corners makes little sense to me.

Meanwhile, Monday’s market action here at home was debilitating. Bank stocks led to the downside (I'm long and growing longer), as did energy stocks like Exxon Mobil (XOM) and Schlumberger (SLB). Media stocks like Comcast (CMCSA) and Walt Disney Co. (DIS) also fell.

The Future

But all of the above is history, and we exist here to look forward.

Looking ahead, I expect another ratchet down in global economic-growth expectations. The only question is to what degree U.S. stock prices have already priced this in.

Not surprisingly, investor sentiment has dropped coincident with lower stock prices. Although Wharton's Dr. Jeremy Siegel is still a "sunshine boy," general market expectations are low and growing lower. I even observed my old friend Thomas Lee retreating a bit in confidence and expectations on a recent CNBC appearance.

But when the most vociferous bulls curb their enthusiasm, it's been my experience that that's often a great time to take the contrarian view and buy.    

As I suggested in yesterday's opener, my judgment is that the S&P 500 is about fairly valued -- although as always, some individual sectors are overvalued and others are undervalued. My missive from yesterday morning clearly delineates my specific overall market view over both the short term (more bullish on weakness) and the intermediate term (bearish).

The Bottom Line: Forget the Past

"The market is like Sears Roebuck; it's a discounter. When the pastrami sandwiches are heaping with lean meat and when the deli man is giving me market tips, you should sell. And when the world looks like it's ending and there's too much fat instead of good meat in the pastrami sandwich at Katz's Delicatessen (because they want to save money and boost margins) served by the same deli man, you should buy."

-- Grandma Koufax

I feel strongly that now isn't the time to listen to the "perma-bears," those renewed and increasingly ubiquitous Cassandras. Just like "perma-bulls," perma-bears aren't attention getters, not money makers.

The time to sell has likely passed. Those opportunities had been in place since last spring and were the outgrowth of a deteriorating fundamental and technical backdrop that many investors ignored.

But while I have a more-constructive market view for the short term my confidence level isn't high. In a fragile-growth setting, too much can upset the apple cart.

So, I'm moving closely around market neutral these days, but actively and opportunistically trading indices through the SPDR S&P 500 ETF (SPY) and the PowerShares QQQ ETF (QQQ). I'm trying to take advantage of the lunatic, exaggerated daily market moves caused by risk-parity strategies, gamma hedging and other quant fools. They're the tail that wags the market's dog, and they provide opportunities for the aggressive trader.

As I recently wrote, this correction may be a time to buy, but not the time to buy. I look at the gap between market prices and intrinsic values -- and unlike many, the lower the market moves, the less fearful I become as the risk-vs.-reward ratio improves.

I'll outline my current strategy in greater detail a little later this morning.

My investment experience is that it's not smart to be fearful when most people are fearful.

I've also come to realize that buyers live higher and sellers live lower (there's comfort in crowds and herds!). That's particularly true in our quant-influenced marketplace. This bizarre behavior has encouraged me to short rips and buy dips over the last year.

In an exchange of e-mails last night with my pal and RealMoneyPro colleague James "RevShark" DePorre, I asked Rev if he though whether last Wednesday's S&P 500 noon low of about 1,815 or Wednesday morning's gap lower at 1,850 were more important to him. Rev responded with the latter, and I get that.

I believe 1,850 could be challenged -- we were within some 25 handles of that on the futures at last check, and last night we were within five handles. But I continue to expect stocks not to challenge 1,815, and I'm prepared to buy gingerly on any further weakness.

My shorting focus has been broad, but my long focus has been on banks -- which have solid profits growth and low valuations -- and retail stocks, which are large beneficiaries of lower oil and low valuations).

The former reported fourth-quarter results that were in-line or better, which I expect to continue despite the challenge of a flatter yield curve that's likely discounting a deep recession.

I also note that Huntington Bancshares (HBAN) this morning announced the acquisition of FirstMerit (FMER), a former holding of mine, for a relatively large premium. Although we've likely seen "Peak M&A" in 2015, I expect some acceleration in takeover activity once the international arena stabilizes.

Those with a more-conservative risk profile should consider staying away from stocks for now because we're basically at fair market value. But personally, I'm starting the day slightly net long, and my next move will likely be to expand my long exposure even further.

I think reasonable values are emerging, depending on your risk profile and timeframes. And despite the volatility and dispiriting price action, I'm not equivocating from my more-constructive near-term market view.

What's most important to me is that lower stock prices bring on a better upside/downside equation in certain sectors and individual equities.

[dougkass]

The Future Is Not What It Used to Be

To say that the U.S. stock market is a casino would be unfair to the casino.

Consider that the S&P 500 declined by nearly 50 points between 12:30 p.m. Friday and 1:45 p.m. yesterday on little news, then rebounded more than 20 points between about 3:15 p.m. and the close. S&P 500 futures then fell broadly last night, but have rallied vigorously this morning to extend yesterday afternoon's late rally -- again, on no real news.

It's been a constant refrain of mine throughout the last two years that our market's mechanism is broken, and that market volatility will be on the ascent:

"The VIX breaches 40 to the upside during the year."

-- Doug's Daily Diary, 15 Surprises for 2016 (Part One)  (Dec. 29, 2015)

Or, as UBS recently put it:

"We would be surprised that in this highly leveraged world, in combination with a structural decline in market liquidity, a seven-year cycle decline would just be mild. We think it's actually just the other way around. In this context, we see last year's rise in volatility as just the start of a period with exceptionally high volatility, where we wouldn't be surprised to see record spikes in volatility over the next 12 to 17 months. So, another key call we have for the next 12 to 15 months is to be long volatility.

Particularly with regards to the ongoing bear market in high yields, we think that volatility in equities is too low and this will be one of the key charts for 2016.

Last year, we argued that we generally see all these divergences as a leading indicator for an important top in global equities. Twelve months later, we are in the next phase of the global rolling-over process. We see more and more markets having already fallen into a bear market. On the other hand, we can clearly say that without a new momentum impulse coming from the fundamental world, the air for the remaining outperformer markets will get increasingly thin."

-- UBS

And, as Zero Hedge noted in this chart:

 Timeframes

"Foot on the pedal Never ever false metal Engine running hotter than a boiling kettle."

-- The Beastie Boys, No Sleep Till Brooklyn 

With so much volatility in the air, I believe that traders/investors must assess their timeframes and risk profiles and not stray. I see players basically facing one of two core options based on their personal investing timeframes:

Short-Term Timeframe. In this setting, it makes sense to try to partner with volatility. This requires an emotionless disposition that means leaving your brain at times at the trading-floor door. Like short selling, this isn't for everyone -- indeed, it's only for the few.

Intermediate- or Long-Term Timeframes. If you have a longer timeframe, attractive opportunities will emerge and you should capitalize on them. But embracing this strategy requires genuine patience and being true to your timeframe.

Navigating the Market

"Price is what you pay, value is what you get."

-- Warren Buffett

I've adopted a negative market view over the last year, and I continue to press it.

I expect the S&P 500 to record a low-double-digit decline for 2016 -- but the trip won't be a straight line downward. Instead, it'll likely consist of continued wild swings in a market that's without memory from day to day.

So, adopting a negative overall view doesn't preclude me from having occasional short-term positive twists -- as I do right now, which has led to my current medium-sized net long exposure.

This can occur particularly when investor sentiment plummets, as I believe it has these days (just check out RBS' "Sell Everything!" call). Brokerages rarely cry "Sell Everything!" at market tops -- they more typically do so at market bottoms. And when bulls become bears (as has been the case recently), that's often bullish for the near term.

As I mentioned yesterday in an interview with Bloomberg Radio (listen here starting at the 4:20 mark), I disagree with market-newsletter publisher Dennis Gartman -- who said earlier that "on balance, the market is right."

I believe the market is inefficient and even irrational at times over the near term, in part due to the role of momentum-based quant strategies. How else can we explain the market highs of last May, followed by the lows of late August, September and October and then the highs of late December?

This volatility creates a near-term dynamic that provides opportunities to traders, which I've embraced. But these trends have also negated the value of charts and technical analysis to some degree. In other words, it's different this time.

Generally, I've picked my spots to "short the rips and cover the dips" -- and thus far, it's worked out just fine over the last year.

At the same time, I've opportunistically traded or invested selectively on the long side, and I plan to continue doing so when good values present themselves. As an example, I've identified the retail and banking industry over the past few months as having attractive intermediate upside/downside ratios.

Importantly, a hedge fund (operating with a book of longs and shorts) must be hedged on the long side owning relative value and on the short side being short on relatively overvalued securities.   

My Current Strategy

"The future is not what it used to be."

-- Yogi Berra

As mentioned above, I'm net long despite a negative overall market view. That's because I see: 1) some emerging values that have developed in the recent vicious market decline, 2) the rise in negative sentiment ("Sell Everything!") and 3) a tradeable bounce possibly occurring over the next few weeks.

Still, I realize that I have to be responsive going forward to changing market conditions. Gamma hedging, risk-parity trading and other quant strategies geared toward allocating to volatility and/or price-momentum tactics have begun to exacerbate the market's short-term directional trends and volatility. This could continue until we see the "Mother of All Flash Crashes" -- something I warned about in my 15 Surprises for 2016.

But heightened volatility and increased random price action could continue even after that. After all, the HFT lobbies are strong, the exchanges are beholden to (and profit from) HFT participants and quite frankly, the U.S. Securities and Exchange Commission is too weak to intervene.

It's a sad state of affairs in that many retail and even institutional investors are rapidly retreating from the investment-playing field. As I've previously written, some very well respected hedge hoggers are folding up their tents (Seneca, SAB Capital, Fortress Investment Group's macro fund (Novogratz etc.). That's because the investing backdrop no longer corresponds to fundamentals and fails to reflect the real economy's condition.

When prestigious hedge funds fold, it's rarely the sign of a market top. Like brokerages that yell "Sell Everything!", it's typically a sign of a market bottom. For this reason and other sentiment-related ones, I'm short term bullish but intermediate-term bearish.

This is the reality of how tough the game has become. If it's too freakin' hard for the hedge-fund industry's kingpins, it's too freakin' hard for most of us.

This will likely change -- but no time soon. I believe there will be No Sleep Till Brooklyn in 2016.

This article originally appeared on Real Money on JAN 12, 2016

[dougkass]

'Something's Wrong! Sell! Sell!'

"Mortimer: That's not right. How can the price be going down?

Randolph: Something's wrong! ... They're selling, Mortimer! ... You, idiot! Get back in there at once and sell! Sell!"

Billy Ray, we are not looking good this morning.

S&P 500 futures were some 35 handles lower at last check following a North Korean nuclear test and a dismal Chinese non-manufacturing PMI report. We appear likely to test Monday's lows on the opening.

"What we have learned from history is that we haven't learned from history." --Benjamin  Disraeli

Let me underscore this morning that rationality wilts and gets sedated in the market when large doses of effortless money are administered (i.e. Federal Reserve stimulus).

At best, a calm occurs. At worse, an unrealistic "bull market in complacency" forms. Investors come to believe that central bankers will indefinitely prevent our markets from returning to normal "price discovery." A new paradigm emerges in which players convince themselves that history doesn't matter.

But reality sets in at some point, leaving investors with the "bag-holder blues" (to quote late financial writer Joe Granville). Or, to quote late mega-investor John Templeton, "The four most expensive words in the English language are: 'This time it's different.'"

Market watcher John Hussman has eloquently pointed out that those who still embrace the bubble in global stock prices will eventually sit down to a banquet of consequences.

"At the peak of every speculative bubble, there are always those who have persistently embraced the story that gave the bubble its impetus in the first place," he wrote. "As a result, the recent past always belongs to them, if only temporarily. Still, the future inevitably belongs to somebody else. By the completion of the market cycle, no less than half (and often all) of the preceding speculative advance is typically wiped out."

Citing Carmen Reinhart and Kenneth Rogoff's classic book This Time Is Different, Hussman added: "Every boom and bust have the same qualities. The hubris and arrogance of financial 'experts' and government apparatchiks makes them think they are smarter than those before them.

"They always declare this time to be different due to some new technology or reason why valuations don't matter," Hussman wrote. "The issuance of speculative debt and seeking of yield due to Federal Reserve suppression of interest rates always fuels the boom and acts as the fuse for the inevitable explosive bust."

Are We Safe as Markets Presume?

I've written repeatedly over the last year that the one question I ask myself every morning is: "Are we as citizens and investors as safe in a flat, connected and networked world as markets presume we are?"

That question, coupled with a slew of fundamental concerns (geopolitical, social, political, economic and profit-related), forms the basis of my cautious market view.

I've expressed my view that both the fundamental and technical deterioration -- i.e., the narrowing market leadership that began in late 2014 -- were sowing the seeds for an important, broad-market top.

In my columns Short in May and Go Away and A Touch of Red May Be Ahead, I long ago identified last spring as the start of a cyclical S&P 500 top. And last month, I even expressed my negativity with some hyperbole (and a measure of frustration that the market had not yet conformed to my design) through two Dr. Seuss parodies, Green Eggs and Stocks: Neither Rocks and The Bull in the Hat.

I juxtaposed the above with my expectation that an "Ah Ha Moment" was at hand  -- a point in time when investors would lose confidence in the Fed and its policies. I also summarized all of this in my 15 Surprises for 2016 (parts one and two), which took a very negative tone and warned of a difficult year ahead.

A Broken Market Mechanism

The market mechanism has become broken, with machines and algos taking a more-dominant role -- filling the vacuum left by the exit of individual investors and a less-active hedge-fund community.

Distortions and malinvestments are occurring as a result, meaning strategies that worked in the past begin to fail -- as do the money managers who relied on them.

More "liquid-alternative" mutual funds closed last year than in any previous other year on record, including those run by JPMorgan Chase (JPM) and Guggenheim Partners. We've also recently seen several hedge-fund firms (including Whitebox, Lutetium, SAB Capital and Seneca) announce plans to close some or all of their funds.

If these "Masters of the Universe" -- the supposed best and brightest minds on Wall Street -- can't figure out our markets, what chance do we mere mortals have?

If my market fears come true this year, it's inevitable that Main Street and the real economy will suffer the adverse impacts of a broken market mechanism and falling stock prices. The word "contagion" hasn't been heard a lot since 2008, but it might appear again in 2016. Actually, we might have already been feeling the market's contagious effects over the past two weeks. 

"Surprise No. 3: 'The Mother of All Flash Crashes'

One of these cyber-attacks causes 'The Mother of All Flash Crashes,' which scares  the hell out of many market participants. The Dow Jones Industrial Average falls by 1,100 points -- the largest one-day point decline in history." -- Doug's Daily Diary, 15 Surprises for 2016 (Part One) (Dec. 29, 2015)

What I'm most fearful of is the possibility (as expressed above) that once the market moves down decisively, risk-parity and gamma-hedging strategies will exacerbate the market downturn -- just as portfolio insurance did during the 1987 Wall Street crash.

Most players shouldn't short stocks. But that said, I currently have 18 stocks and indices on my "Best Short Ideas" list. I don't know many commentators who have such a broad menu of shorts that they recommend.

The Bottom Line

"It ain't cool being no jive turkey so close to Thanksgiving." -- Trading Places

This is no drill. I've consistently argued that investors should err on the side of conservatism these days, and that T.I.N.A. ("There Is No Alterative" to stocks) is B.S. (With apologies to my pal Strategas' Jason Trennert, who coined the term "T.I.N.A.")

As an expression of my negative market view, I'm currently short on the Chinese, U.S. and European stock markets. In fact, the SPDR S&P 500 ETF (SPY), PowerShares QQQ ETF (QQQ), iShares China Large-Cap ETF (FXI), iShares MSCI Germany ETF (EWG), iShares MSCI United Kingdom ETF (EWU) and iShares MSCI France ETF (EWQ) are all on my "Best Short Ideas" list.

Being liquid and watching what happens -- or for aggressive investors, being short -- are reasonable strategies given the numerous uncertainties and potentially adverse outcomes we face in a market that's without memory from day to day.

[dougkass]

15 Surprises for 2016 (Part Deux)

Here's the remainder of my 15 Surprises for 2016 (click here for part one).

Again, these aren't "predictions" for 2016, but rather a list of potential events that have a reasonable chance of occurring. Again, I call them "possible improbable events" that you should consider when planning out your investment strategy for the coming year:

Surprise No. 6: Stagflation I think stagflation could join "screwflation" as a concern for 2016. Wages could rise and non-energy commodities (particularly agricultural) could pass the Federal Reserve's inflation target despite disappointing U.S. growth.

Although we could see slowing and recession-like growth in 2016's third and fourth quarters, the yield curve won't invert. But oil and a drought that causes higher agricultural prices could raise headline inflation to well above the Fed's target.

Surprise No. 7: The Fed Doesn't Raise Rates Low U.S. nominal GDP growth (under 3%) didn't stop the Fed from raising rates earlier this month, even though the indicator was close to 7% the last time the central bank initiated a rate-hike cycle in 2004. And prior to the 2004 cycle, the Fed raised rates at a time when nominal GDP growth ranged from 5% to 7%.

However, I think 2015's rate hike will prove to be a policy error. Despite the consensus of two to three more hikes in 2016 (and the Fed's own forecast of four increases), I predict the Fed won't raise rates at all in 2016. Chairman Janet Yellen will be roundly criticized for failing to raise interest rates before 2015, and confidence in the Fed will begin to mirror the low readings previously reserved for Congress.  

Confidence will deteriorate ever further as America falls into recession. An attempt by several senators to replace Yellen will falls short for procedural reasons, but pressure will remain on her throughout the year and into 2017.

Surprise No. 8: China and Russia's Economies Falter China's real GDP growth rate (at least as stated) could fall below 5%. Unemployment rises and riots ensue, forcing the government to clamp down on social media.

As a form of distraction (and an attempt to expand its political and economic reach), China flexes its military muscle and gets more aggressive in the South China Sea. A hot-headed ship captain causes a crisis and President Obama considers sending U.S. ships into the disputed waters.

Despite a rise in oil prices, Russia's economy implodes. Russian leader Vladimir Putin grows increasingly irrational and retaliatory towards his perceived enemies, precipitating more confrontations and crises.

Surprise No. 9: The European Union Begins to Unravel German Chancellor Angela Merkel's open-door immigration policy backfires and causes her to resign, while Britain leaves the EU (a "Brexit") under the assault of Euro-skepticism.

Separatist initiatives in Scotland and other countries advance and France's National Front party rises to new heights in the face of immigration fears. Support to Greece and other EU peripheral countries diminishes, causing another emerging-market crisis. European borders are shuttered and trade comes to a halt.

Surprise No. 10: It's Hillary vs. The Donald The U.S. far left and far right both surge in popularity as voters lose faith in the political status quo. Despite his rude and crude campaign, a series of terrorist acts within U.S. borders propels Donald Trump ahead of all of his Republican competitors.

The "bromance" between Trump and rival GOP presidential candidate Sen. Ted Cruz continues, and The Donald makes the Texas senator his running mate. Clinton selects former San Antonio mayor (and current Housing Secretary) Julian Castro as her running mate.

The first Clinton/Trump presidential debate attracts nearly 100 million viewers. Given the world's chaotic landscape, the November election is much closer than expected, but Clinton beats Trump 293 electoral votes to 245.

As her first initiative (even before her January inauguration), President-elect Clinton adopts a populist crusade that immediately attacks income and wealth inequality by recommending a large "wealth tax" and an increase in the U.S. minimum wage.

Clinton generally snubs the Republican Party and fills her cabinet with some of these individuals: Bernie Sanders (Veterans Affairs), Roger Altman (Treasury), Cory Booker (Housing and Urban Development), Joseph Sestak (Defense), Howard Dean (Health and Human Services), Wesley Clark (Homeland Security), Jennifer Granholm (Commerce) and Kamala Devi Harris (Justice).

Surprise No. 11: Housing and Autos Tank The housing and auto industries are exposed as Potemkin Villages on weak foundations. Home prices drop by over 5% as affordability gets stretched, mortgage rates climb and unemployment rates bottom out.

As for cars, rising interest rates, the fear of sooner-than-expected smart mobility and autonomous vehicles (coupled with a sharp drop in SAAR) pummels Ford (F) and General Motors (GM). Fierce competition appears from Alphabet (GOOG, GOOGL),Tesla (TSLA) and Apple (AAPL) for a share of the emerging mobility market. Add in a spike in auto-loan delinquencies and autos become one of 2016's worst-performing sectors.

General Motors "tax inverts" in response to dour sales and the lack of corporate-tax reform. It merges with European-based Rolls Royce Holdings (RYCEY).

Surprise No. 12: Warren Buffett Stumbles (Literally and Figuratively) The Oracle of Omaha's core investments -- Coca-Cola (KO), IBM (IBM), Wal-Mart (WMT), Deere (DE), American Express (AXP) and Wells Fargo (WFC) -- continue to falter as their protective "moats" dry up.

Investors become further concerned when Buffett falls and breaks a hip, causing him to be away from Berkshire Hathaway (BRK.A, BRK.B) for several months. As result (and in the wake of move lower in Berkshire's share price to below book value), Buffett is forced to announce the name of his successor, who begins to pick up some of the Oracle's responsibilities in 2016.

Surprise No. 13: Goodbye FANG and NOSH, Hello CRABBY TFANG and NOSH -- Nike (NKE), O'Reilly Automotive (ORLY), Starbucks (SBUX) and Home Depot (HD) -- fall back to Earth and join the market's soldiers.

TFANG and NOSH's market leadership is replaced by a new market leader: CRABBY. That's Citigroup, (C), Radian (RDN), Allstate (ALL), Bank of America (BAC), theBlackstone Strategic Credit closed-end fund (BGB) and Allegheny Corp. (Y).

Surprise No. 14: More Unicorns Expect more private-equity unicorn dropouts in 2016 than you'd find truants in Animal House's Delta fraternity.

Excessive valuations will again remind Silicon Valley that "fat, drunk and stupid is no way to go through life, son." Cue the music.

Surprise No. 15: Individual Situations Here are some individual stock, market sector and other surprises for 2016:

Apple makes a $20 billion+ acquisition and the shares trade at $90 after two consecutive, large earnings misses.

JPMorgan Chase (JPM) and Morgan Stanley (MS) merge.

Goldman Sachs (GS) significantly bolsters its money management operations by acquiring T. Rowe Price (TROW).

Two private-equity firms compete to acquire retailer Macy's (M).

Web entrepreneur David Rosenblatt replaces Marissa Mayer as CEO of Yahoo(YHOO).

After three years of overpromising and underdelivering, Douglas Oberhelman resigns as CEO of Caterpillar (CAT).

Stung by large losses in Chesapeake Energy (CHK) , Cheniere Energy (LNG),Freeport McMoRan (FCX) and other companies, Carl Icahn steps down and appoints his son Brett as CEO of Icahn Enterprises (IEP). Icahn also meaningfully reduces his investment in Apple in 2016.

Rigid drone legislation and the institution of an Internet commerce sales tax stall the share price advance at Amazon (AMZN). Instead, the stock falls by over 30%.

Despite a weakening economy (and against conventional wisdom), the high-yield bond sector is among 2016's top-performing asset classes. The spread-widening we saw in 2015's second half ends in 2016's first six months, in part because a sharp oil-price spike results in a brilliant recovery by energy-related junk bonds.

2016's best market sectors: Defense, banks and fertilizers. Defense stocks -- i.e.,Lockheed Martin (LMT), Boeing (BA) and Raytheon (RTN) -- soar as terrorism at home and abroad causes a broad response and military initiatives. Bank stocks benefit from a cessation of legal-and-compliance costs and an upward-sloping yield curve, but a second-half U.S. recession cuts into first-half gains. Fertilizer stocks rebound mightily after droughts hit around the world.

2016's worst market sectors: Media, transports (particularly airlines and autos), electrical utilities, pharma/biotech and REITs. Terrorism, an accelerated pace of "cord cutting" and lower U.S. economic activity are a toxic cocktail for Comcast (CMCSA), Delta Air Lines (DAL), Starbucks, Nike and Walt Disney Co. (DIS). (ESPN subs drop below 80 million by year's end.) Prices for theme parks, coffee and sneakers all fall as demand elasticity finally surfaces during the incipient recession that occurs in the year's second half. A rapid drop and improved solar technology pose a competitive threat to electric utilities, while the Clinton administration comes down hard on drug prices. Finally, on REITs -- see the next bullet point!

Mall sales traffic collapses. Several mall-based REITs perform the way of master limited partnerships did in 2015. Dividends get slashed in the face of a slowing economy, rising oil prices and the continued Internet inroads that are rapidly changing consumer behavior.

Sears (SHLD) finally succumbs to a weaker domestic economy and a deteriorating shopping experience at its stores and goes bankrupt. Icahn accumulates Sears bonds and takes control of the company out of bankruptcy.

The aforementioned issues (the devastation of malls and a Sears bankruptcy) precipitate a U.S. non-residential real estate crisis.

The South Beach Housing Bubble starts a collapse in high-end real estate prices that extends to New York City,  the Hamptons and Los Angeles -- which fall by 15% on average. Nationally, home prices drop by 5%.

Water grows more scarce and a new, powerful "Silicon Valley Northwest" emerges. The Bill and Melinda Gates Foundation IPOs a home-grown company that develops a breakthrough technology that inexpensively turns wastewater and sewage into potable water. (Bill Gates contributes his entire stake in the company to charity.)  Later in the year, the Gates Foundation announces additional important innovations in health care, medicine and nutrition.

Sovereign-wealth funds (which are currently about twice the size of the hedge-fund industry) exit the markets and redeem from hedge funds, exacerbating the market's slide.

Hedge funds experience record redemptions and outflows as investors get impatient with high fees and poor investment performance.

Several legendary hedge hoggers (each with funds holding assets under management over $5 billion) close shop. The pressure is particularly intense on activist investors who find themselves with large and concentrated holdings. As in Hotel California, "you can check out any time you like, but you can never leave" (without large losses). A few of these former Wall Street titans retire to a new high-end subdivision at Del Boca Vista in South Florida.

There are big changes in the business media. CNBC's Joe Kernen joins Maria Bartiromo as an anchor at Fox Business Network. Andrew Ross Sorkin's Showtime series Billions captures seven Emmy nominations, so he departs both CNBC and The New York Times for MSNBC as host of the new Sorkin Report. Carl Quintanilla joins NBC's The Today Show. Seema Mody and David Faber (in a returning role!) replace Joe and Andrew on CNBC's Squawk Box. Kelly Evans leaves CNBC and joins Bloomberg in a dual role, with Tom Keene as a co-anchor of Market Surveillance and as anchor in a new 4 p.m. segment.

Position: Long C, RDN, BGB, BAC, M, WMT (small); Short AAPL, F, GM, SPY, QQQ, IYR, FXI, EWG, EWQ, EWU, DIS, AAPL, CMCSA, SBUX, NKE, BRK.B (small), FB (small), NFLX (small), TSLA (small)

[dougkass]

15 Surprises for 2016 (Part One)

"I begin every day by asking three important questions. One among them is this: 'In a paperless and "cloudy" world, are we as investors and citizens as safe as the markets assume?

I've posed this question in my diary on at least 10 occasions in the past year, as it's been a frequent concern of mine. On Friday in Paris, we were reminded again that we live in an open society and, as such, we are exposed to ISIS jihadists. ... As I have pointed out many times, I have feared the exposure of our free society to acts of terrorism for some time. As citizens and as investors, we are simply not as safe as the markets assume us to be."

-- Doug's Daily Diary, The Constant Risk of Terror (Nov. 14, 2015)

My overriding theme and the central drama for the coming year is that unexpected events can take on greater importance as the Federal Reserve ends its near-decade-long Zero Interest Rate Policy.

Consensus premises and forecasts will likely fall flat, in a rather spectacular manner. The low-conviction and directionless market that we saw in 2015 could become a no-conviction and very-much-directed market (i.e. one that's directed lower) in 2016.

There will be no peace on earth in 2016, and our markets could lose a cushion of protection as valuations contract. (Just as "malinvestment" represented a key theme this year, I expect a compression of price-to-earnings ratios to serve as a big market driver in 2016.)

In other words, I don't think 2016 will be fun. I think few investors (and that includes Warren Buffett) will be Tap Dancing to Work. In fact, I think investing will prove unprofitable for many -- more so than in any year since 2008.

Once again, I'm taking on a decidedly negative tone -- suitable to in my old early 1990s role as "The Bear of Boca." I'm basing my bearishness on a backdrop of continued heinous acts of terrorism, economic and profit disappointment and the general gloom and doom that's immersing our citizens and our markets.

Risk will happen fast over the next 12 months, and "T.I.N.A." -- the view over recent years that "there is no alternative" to stocks -- will prove to be just another spurious justification to be bullish in stocks. In its place, I think cash will be anointed as 2016's new king.

While some might accuse me of being apocalyptic, I contend that I'm simply raising the flag of common sense in a most uncertain world.

But again, it's important to note that my surprises aren't intended to be predictions, but rather events that have a reasonable chance of occurring. I call these "possible improbable events."

And again, the purpose of putting together this list is to help you position a portion of your portfolio in accordance with outlier events, with the potential for large payoffs on small wagers/investments.

With that said, here are the first five of my 15 Surprises for 2016 (I'll post the remaining ones later today):

Surprise No. 1: Terrorism Dismantles an Already Fragile Global Recovery I fear we'll see attacks that demonstrate how terrorism incidents are systemic and not (as the consensus sometimes believes) simply isolated. It could become apparent that we face a broad, aggressive wave of terrorism aimed (as expressed by ISIS) at defeating the West's world domination.

Acceptance of this notion would cause significant disruption in global markets and the world's economies. Shares in airlines, hotels, entertainment companies (especially theme-park related) might suffer the most throughout the year.

Surprise No. 2: Terrorism Goes Cyber Middle Eastern, Russian and Chinese hackers successfully invade the U.S. financial system's computers at various points throughout 2016. They consistently launch destabilizing attacks against multiple trading platforms (the New York Stock Exchange, the Chicago Mercantile Exchange etc.) and the overnight electronic settlement system.

This causes a series of temporary multi-day trading halts, shattering confidence in our markets.

Surprise No. 3: 'The Mother of All Flash Crashes' One of these cyber-attacks causes "The Mother of All Flash Crashes," which scares  the hell out of many market participants. The Dow Jones Industrial Average falls by 1,100 points -- the largest one-day point decline in history.

Almost immediately following a Democratic presidential win in November, President-Elect Hillary Clinton attacks the market-rigging, unholy alliance between high-frequency traders the stock exchanges. A special congressional commission is formed after the flash crash to address the HFT industry and its fellow travelers.

In an attempt to correct the unfair playing field that's evolved, the government declares co-located servers illegal and bans "spoofing" and other dirty work that's become routine in the HFT industry. The market's fragmentation and illusion of depth that have allowed quants to profit at the expense of other investors reverses as new, punitive and costly regulations threaten Wall Street's "dark pools."

However, legislation from Sen. Elizabeth Warren (D-Mass.) to revert both the Nasdaq and New York Stock Exchange back to non-profit status fails to make any progress.

Surprise No. 4: Terrorism Hits Mideast Oil Infrastructure The Islamic State destroys a significant amount of Mideast oil-producing countries' infrastructure. This occurs at the same time more violence erupts in the Niger Delta, Algeria suffers from political chaos and a coup disrupts Venezuela's oil production.

While outsized oil inventories initially stem energy-price increases, crude rises above $60 a barrel in 2016 -- sparking, among other issues, fears of reflation. (Energy stocks continue to falter at first, then soar in response to the Mideast hostilities.)

Surprise No. 5: America Falls into Recession and Stocks Tank Too much debt, too little growth, fiscal-policy paralysis, a "spent" Federal Reserve and limited capital spending (which adversely impacts productivity) weigh down stocks in 2016. So do crony capitalism, geopolitical instability a further narrowing of market leadership and a further technical breakdown.

The current U.S. expansion is now more than 70 months old, one of the longest in history. There have been six recessions since 1971, and the S&P 500's average drop during them is 36%. I predict 2016 will see the seventh recession in the last 45 years, with stocks experiencing a 20% decline.

"You may like them (stocks). You will see. You may like them, but not for me."

-- Doug's Daily Diary, Green Eggs and Stocks: Neither Rocks (Dec. 17, 2015)

Few asset classes will be spared, and household net worths will suffer. Rising bond prices had the effect of somewhat buffering falling stock and home prices in the last downturn. But we won't be so fortunate this time as stocks, real estate and bond prices will likely all decline at the same time.

Other key economic/market features of the year:

U.S. real GDP suffers two back-to-back declines in 2016's third and fourth quarters. Corporate profits turn negative in the second quarter as the largest number of earnings guidedowns since the Great Decession develops.

Profit margins drop precipitously as revenues come in well below expectations and costs rise ever higher.

Productivity will decline in the face of the past few years' limited capital expenditures.

S&P 500 stocks' 2016 earnings per share will come in under $100 (dropping off dramatically in the second half). That's more than 15% below today's consensus expectations.

Price-to-earnings multiples contract.

Share buybacks are 50% lower in 2016 vs 2015.

Merger-and-acquisition activity slows to a crawl.

2016 produces the lowest number of IPOs in eight years.    

The U.S. dollar's bull run ends. Our currency fails to appreciate as the consensus expects. Instead, it slumps in response to terrorism within our borders and to cyberattacks directed at our financial system.

Oil temporarily exceeds $60 a barrel.

The U.S. housing market suffers in price and sales volume.

Auto industry sales (SAAR) decline by over 2 million units to under 15 million.

Another peak is seen in 2016: "Peak Employment."

Despite weakening economic growth, the 10-year Treasury's yield spikes to 3% on inflation scares.

The VIX breaches 40 to the upside during the year.

Position: None

[dougkass]

Prelude to My 15 Surprises for 2016 (Second Movement)

"How'm I doin'?" --Ed Koch, former New York City mayor

So, I said we'd be grading the surprises for 2015 that I unveiled a year ago.

Turns out I had a very good year relative to my historic percentages.

While over recent years many of my Surprise Lists have been eerily prescient (e.g., my 2011 surprise that the S&P 500 would end exactly flat was exactly correct), my 15 Surprises for 2015 were more than 60% correct. Taking into account my "Also Ran" Surprises, the hit ratio would have exceeded 70%.

Two years ago, my 15 Surprises for 2014 had a success rate of about 40%, which is about in line with what I have achieved over the last 11 years.

As we entered 2015, most strategists expressed a constructive economic view of a self-sustaining domestic recovery, held to an upbeat (though not wide-eyed) corporate profits picture and generally shared the view that the S&P 500 would rise in the range of 8% to 10%.

Those strategists proved to be substantially incorrect on profit growth (at mid-year 2014, S&P profit forecasts eclipsed $130 a share -- that will turn out to be about $20 a share too high), were too optimistic regarding domestic and global economic growth, and felt that excessive liquidity provided by the world's central bankers would continue to lift valuations and promote attractive market gains in 2015. Not one major strategist foresaw the emerging deflationary conditions, the precipitous drop in the price of oil and the generally broad decline in all commodities exported by the BRIC countries (encompassing Brazil, Russia, India and China), which led to a bear market in industrial, cyclical and commodities-based equities.

Many readers of this annual column assume that my Surprise List will have a bearish bent (and to be sure, that is the case for 2016). But I have not always expressed a negative outlook in my Surprise List. Three years ago my 2012 Surprise List had an out-of-consensus positive tone to it, though 2013's list was noticeably downbeat relative to the general expectations. As I previously noted, in 2014 my success rate was at about 40% (which included five also-ran predictions).

This contrasted with my 15 surprises for 2013, which had the poorest success rate since 2005's list (20%).

By comparison, my 2012 Surprise List achieved about a 50% hit ratio, similar to my experience in 2011. About 40% of my 2010 surprises were achieved, while I had a 50% success rate in 2009, 60% in 2008, 50% in 2007, 33% in 2006, 20% in 2005, 45% in 2004 and 33% in 2003, the first year of my surprises.

Below is a report card of my 15 surprises for 2015:

Surprise No. 1: Faith in central bankers is tested, malinvestment becomes the "it" word in 2015 -- VERY RIGHT

Surprise No. 2: The U.S. stock market falters in 2015 -- RIGHT

Surprise No. 3: The drop in oil prices fails to help the economy -- VERY RIGHT

Surprise No. 4: The Mother of all Flash Crashes occurs -- WRONG

Surprise No. 5: The great three-decade bull market in bonds is over in 2015 -- RIGHT

Surprise No. 6: China devalues its currency by more than 3% versus the U.S. dollar --VERY RIGHT

Surprise No. 7: Apple (AAPL) becomes the first $1 trillion company -- WRONG (though it got close in the first half of the year!)

Surprise No. 8: Legislation is introduced that allows for repatriation of foreign cash --WRONG

Surprise No. 9: Energy goes from the worst-performing group in 2014 to the best-performing group in the first half of 2015 and then falls back later in the year -- RIGHT

Surprise No. 10: More chaos in the Democratic Party -- WRONG

Surprise No. 11: Food inflation accelerates after Russia halts wheat exports -- WRONG

Surprise No. 12: Home prices fall in the second half of 2015 -- RIGHT

Surprise No. 13: Google (GOOGL) institutes a share buyback and shaves capital spending – VERY RIGHT -- and volatility rises -- RIGHT

Surprise No. 14: Berkshire Hathaway (BRK.B) makes its largest acquisition in history --VERY RIGHT

Surprise No. 15: A derivative blowup precipitates an abrupt market drop -- RIGHT

Several of my Also-Ran Surprises proved prescient:

China's Real GDP growth falls below 5% in 2015 as economic growth decelerates markedly in the second half of the year -- PROBABLY RIGHT

An accounting "discrepancy" is found at Alibaba (BABA). The shares plummet and the hedge fund community feels the pain -- RIGHT

The price of crude oil drops below $40 a barrel in the second half of 2015 -- VERY RIGHT

The consumer price index turns negative (year over year) -- ALMOST RIGHT

IBM (IBM) whiffs and the share price drops below $125 a share and Berkshire Hathaway suffers a nearly $4 billion loss (on paper) – ALMOST RIGHT

What Was the Consensus for 2015 and What Is the Consensus for 2016?

"In ambiguous situations, it's a good bet that the crowd will generally stick together -- and be wrong." --Doug Sherman and William Hendricks

"We expect the growth recovery to broaden as global growth picks up to 3.4% in 2015 from 3% in 2014. Inflation is likely to remain low, in part due to declines in commodity prices, and as a result monetary policy should remain easy. We think this backdrop supports a pro-risk asset allocation." --Goldman Sachs, Global Opportunity Asset Locator (December 2014)

As we entered 2015 there was a generally upbeat outlook for global economic and profit growth, as well as optimism regarding the prospects for the U.S. stock market. Projections for bond yields were universally for higher yields throughout the year, and the same could be said for the general expectation of rising oil prices. As is typical, most sell-side projections for earnings, the economy, bond yields and stock prices were grouped in an extraordinarily tight range.

Both the trajectory of U.S. and global economic growth disappointed the consensus in 2015.

S&P earnings were materially lower than expectations despite more-aggressive-than-anticipated share repurchase programs, lower depreciation and interest expenses and a decline in effective tax rates.

Bond yields failed to rise, ending the year more or less in line with year-end 2014.

Deflationary forces were also a surprise to economists, strategists and to the Fed. Most notably, no one projected that oil prices would fall to under $35 s barrel and that the Bloomberg Commodity Index would hit a multiyear low.

Stock prices ended the year relatively flat, at about 10% lower than the mean forecast.

There was a "stealth" bear market in 2015, with numerous sectors down dramatically and the average security ending the year well below its yearly high.

As we enter 2016, investors and strategists again are grouped in a narrow consensus and expect a sweet spot of global economic corporate profit growth that generally will translate to higher stock prices of around 8% or more.

Again, let's use Goldman Sachs' 2016 views of expected economic growth, corporate profits, inflation, interest rates and stock market performance as a proxy for the consensus for the coming year. (The brokerage's 2015 forecasts are in parentheses):

2015/2016 U.S. Real GDP:

2015: 2.50% (GS estimate was up 3.1%)

2016: 2.30%

Source: GS US Economics Analyst, Economic Forecasters' Hits and Misses in 2015, page 7

2015/2016 Global Real GDP:

2015: 3.10%* (GS estimate was up 3.6%)

2016: 3.50%

Source: GS Internal Systems, ERWIN Database, Global Economics Analyst, Our New Global CAI: A Return to Decent Growth, page 1

2015/2016 S&P 500 Earnings Per Share:

2015: $109 (GS estimate was $122)

2016: $120

Source: GS US Weekly Kickstart, The Fed Awakens: A long time ago in a galaxy far, far away ... rates were once above zero, page 1

Year-end 2015/2016 S&P 500 Price Target:

2015: 2000 (GS estimate was 2100)

2016: 2100

Source: GS US Weekly Kickstart, The Fed Awakens: A long time ago in a galaxy far, far away ... rates were once above zero, page 21

2015/2016 Consumer Prices (Consumer Price Index):

2015: 0.10% (GS estimate was up 1.0%)

2016: 1.40%

Source: GS US Economics Analyst, Economic Forecasters' Hits and Misses in 2015, page 7

2015/2016 Closing Yield on the U.S. 10-year Treasury note:

2015: 2.30% (GS estimate was 3.00%)

2016: 3.00%

Source: GS US Economics Analyst, Economic Forecasters' Hits and Misses in 2015, page 7

And thus ends our look back.

Next comes the main event -- My 15 Surprises for 2016! See you soon!

(Editor's note: An earlier version of this posting incorrectly listed Surprises No. 9, 12 and 15 as "wrong" instead of the correct "right," and incorrectly calculated the percentage of 2015 surprises that proved to be correct.)

Position: Short AAPL

[dougkass]

Prelude to My 15 Surprises for 2016 (First Movement)

It's that time of the year again! Time this morning for my 15 Surprises for 2016, which I'll unveil in a bit.

"In this age of infinite distraction. when the entitled elect themselves, the party accelerates and the brutal hangover is inevitable." --Dr. Michael Burry (he profited from "The Big Short"), 2012 UCLA Commencement Speech 

"Never make predictions, especially about the future." --Casey Stengel (also short in stature) 

"Those who are easily shocked should be shocked more often." --Mae West (she liked only two types of men -- long and short)

 "You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right." --Legendary value investor Ben Graham (who in the short term recognized the market was a voting machine, not a weighing machine)

"Timid men prefer the calm of despotism to the tempestuous sea of liberty." (Think central bank intervention!) --Thomas Jefferson (Founding Father and long of stature)

I've never walked the same path in my investment career that others have found comfortable and I'm not going to start now. You see, I find beauty in a variant view. It's satisfying intellectually, analytically and financially (at least when you're correct). There's something special about adopting a non-consensus view and watching it become reality despite protests from many corners. This notion forms the basis for my annual Surprise List.

The purpose of my annual Surprise List is to get readers to think more deeply about a variety of issues. As you read the installments to follow, it will become clear that my surprises this year are substantially out of consensus -- more so than in any year I can remember. As The Dude says in "The Big Lebowski," "Yeah, well, you know, that's just, like, my opinion, man." 

By means of background and for those new to Real Money Pro, 13 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. Wien originally delivered his list while chief investment strategist at Morgan Stanley, then Pequot Capital Management and now at Blackstone. (Byron Wien's list will be out in early January and it is always fun to compare our surprises).  Here was Byron's Surprise List for 2015.  

It takes me about three weeks of thinking and writing to compile and construct my annual Surprise List column. I typically start with about 40 surprises, which are accumulated during the months leading up to my column. I cull the list to come up with my final 15 Surprises. (Last year I included 10 also-ran surprises.) 

I often speak to and get input from some of the wise men and women that I know in the investment and media businesses. I always have associated the moment of writing the final draft (in the weekend before publication) of my annual Surprise List with a moment of lift, of joy and hopefully with the thought of unexpected investment rewards in the New Year.

This year is no different.

I set out as a primary objective for my Surprise List to deliver a critical and variant view relative to consensus that can provide alpha or excess returns. The publication of my annual Surprise List is in recognition that economic and stock market histories have proven that, more often than generally thought, consensus expectations of critical economic and market variables may be off base.

History demonstrates that inflection points are relatively rare and that the crowds often outsmart the remnants. In recognition, investors, strategists, economists and money managers tend to operate and think in crowds. They are far more comfortable being a part of the herd rather than expressing -- in their views and portfolio structure -- a variant or extreme vision.

Confidence is the most abundant quality on Wall Street as, over time, stocks climb higher. Good markets mean happy investors and even happier investment professionals.

The factors stated above help to explain the crowded and benign consensus that every year begins with, whether measured either by economic, market or interest rate forecasts.  But an outlier's studied view can be profitable and add alpha. Consider the course of interest rates and commodities in 2014, which differed dramatically from the consensus expectations. And consider my outlier view in late 2014 that the drop in oil prices would fail to help the economy and that OPEC would come close to dissolution and oil prices would plummet.  An investor could have done quite well by following that message of 15 months ago by avoiding energy stocks in 2015.

To a large degree the business media perpetuates group-think and coddles investors, often into a false sense of security. Consider the preponderance of bullish talk in the financial press. All too often the opinions of guests who failed to see the crippling 2007-2009 drama are forgotten and some of the same (and previously wrong-footed) talking heads are paraded as seers in the media after continued market gains in recent years. Memories are short, especially of a media kind. Nevertheless, if a criterion for appearances was accuracy, there would have been few available guests in 2009-2010 qualified to appear on CNBC, Bloomberg and Fox News Business.

Indeed, after seven years of market prosperity, the few secular investment bears remaining are often ridiculed openly by the business media in their limited appearances, reminding me of Mickey Mantle's quote, "You don't know how easy this game is until you enter the broadcasting booth."

Abba Eban, the Israeli foreign minister in the late 1960s and early 1970s once said that the consensus is what many people say in chorus, but do not believe as individuals. GMO's James Montier, in an excellent essay published several years ago, made note of the consistent weakness embodied in consensus forecasts:

"Economists can't forecast for toffee ... 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, unemployment, stock market price targets and pretty much everything else ... If we add greater uncertainty, as reflected by the distribution of the new normal, to the mix, then the difficulty of investing based upon economic forecasts is likely to be squared!"

Lessons Learned Over the Years

"I'm astounded by people who want to 'know' the universe when it's hard enough to find your way around Chinatown." -- Woody Allen

"Let's face it: Bottom-up consensus earnings forecasts have a miserable track record. The traditional bias is well-known. And even when analysts, as a group, rein in their enthusiasm, they are typically the last ones to anticipate swings in margins." -- UBS (top 10 surprises for 2012)

There are five core lessons I have learned over the course of my investing career that form the foundation of my annual surprise lists:

How wrong conventional wisdom can consistently be.

That uncertainty will persist.

To expect the unexpected.

That the occurrence of Black Swan events are growing in frequency.

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.

Let's get back to what I mean to accomplish in creating my annual Surprise List.

It is important to note that 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 a practical one -- that is, to consider positioning a portion of my portfolio in accordance with outlier events, with the potential for large payoffs on small wagers/investments.

Since the mid-1990s, 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. It remains, more than ever, maintenance-oriented, conventional and group-think -- or group-stink, 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 were 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.

Nothing is more obstinate than a fashionable consensus, and 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, Citicorp, the uninterrupted profit growth at Fannie Mae and Freddie Mac, housing's new paradigm in the mid-2000s of non-cyclical 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.

But enough of that rant.

In the second movement of the "Prelude to My 15 Surprises for 2016," we'll issue a report card on my 2015 surprises. Check back soon!

Position: None

[dougkass]

10 More Wall Street Lessons

"You only think I guessed wrong! That's what's so funny! I switched glasses while your back was turned! Ha ha, you fool! You fell victim to one of the classic blunders."

-- Vizzini to Westley, The Princess Bride

Like the The Princess Bride's Man in Black, who challenged Vizzini to a battle of wits (to the death) over Princess Buttercup, we remain challenged during the month of December to beat Mr. Market and deliver good investment returns.

"Traveling through hyperspace ain't like dusting crops, boy."

-- Han Solo, Star Wars

But accept this challenge we must, even if we learn that it sometimes pays to "Fade the Force!"

Two weeks ago after the market's schmeissing, I outlined what I see as Wall Street's Top 10 Lessons. And today, following a second market schmeissing on Friday, I present 10 more market lessons that we should learn from last week:

Lesson No. 1: Respect Technical Deterioration A bifurcated market, narrowing leadership, weak breadth, expanding new lows and fewer new highs and are almost always negative signs that you shouldn't ignore.

Lesson No. 2: Volatility Brings Out the Worse in Markets Sharp, abrupt moves in asset classes (stocks, commodities and currencies) are often precursors to problems in the real economy and the markets (e.g. energy products' dramatic price decline). In markets, as in life, the only certainty is the lack of certainty. So, we should never be confident of view.

Lesson No. 3: The Fed Is Friend and Foe The Federal Reserve's extended period of liquidity injections and 0% interest rates probably pulled forward sales and economic activity. But now, the market seems to be "sensing" the many peaks that I've previously said could lie over the horizon.

When fund flows change and the movie "goes into reverse" as the Fed begins to tighten (even by only 25 basis points), markets have often had a negative response. Stated simply, the credit cycle is turning and the winter is coming.

Lesson No. 4: The World Is Flat We as investors or as citizens (as the San Bernardino shootings showed) aren't nearly as safe as markets presume.

No country is an island. Forget the concept of America as an "oasis of prosperity" and recognize that the world is more fragile and vulnerable than ever before -- economically, socially, geopolitically and from a market standpoint.

The lesson here is that we shouldn't be overly confident in view or portfolio structure. Rather, consider the benefits of diversification and larger-than-usual cash reserves.  

Lesson No. 5: Ego Kills Ego kills -- and what looks and acts like a jackass usually is a jackass (see Martin Shkrlei).

And as late Barron's columnist Alan Abelson used to say: "Pride goeth before fall." I once sent Alan Abelson a non-fiction book, and he called me to say that he never read non-fiction because "you can't make up the crap that goes on on Wall Street. It makes better reading than any other non-fiction."

Lesson No. 6: Buy the Rumor, Sell the News As the old saying goes: "Buy the rumor, sell the news." Conversely, it often pays to sell or short on the rumor (and the hype) and buy or cover on the news.

Case in point: shorting Walt Disney Co. (DIS) on the Star Wars hype. The lesson that the great contrarian investors teach us is to find a trend whose premise is false and bet against it. This year has had plenty of such opportunities, from shorting energy stocks to buying financials back in March.

Lesson No. 7: Listen to Yale Hirsch As the legendary Hirsch, founder of The Stock Trader's Almanac, once famously said: "If Santa Claus should fail to call, bears may come to Broad & Wall."

Lesson No. 8: Common Sense Is Uncommon As Marty Zweig once advised: "Don't fight the Fed." And as Warren Buffett recommends: "Be greedy when others are fearful."

Recognize that corrections and bear markets are borne out of good news (think peak housing, peak autos and peak profits). Conversely, rallies and bull markets are borne out of bad news (think the "generational low" of March 2009).

Lesson No. 9: We Have Met the Enemy, and He Is Us Be independent of view and thought, do your own homework and read as much as possible.

Don't arbitrarily follow the "big whales," nor the TV "talking heads" -- who often use sound bytes instead of rigorous analysis (and are sometimes are selling you something).

Neither the "perma-bulls" nor "perma-bears" that parade in the business media are money makers; they're merely attention getters. They're often inflexible, intransigent and rarely vacillate from a predetermined or fixed view. As Westley said in The Princess Bride: "We are men of action. Lies do not become us."

You can learn another lesson by looking at Apple (AAPL) and what happened to its share price this month.

Apple has been underperforming since May. The shares' relative strength made a new low recently (undercutting January), and its price rang up its lowest close since late August's market meltdown. All told, AAPL is now down by 20% from its yearly high and is almost 15% lower than when the stock joined the Dow Jones Industrial Average.

Despite that, sell-side analysts remain exuberant, with 40 of them rating the stock as buy/overweight and only one giving AAPL a sell recommendation. (Three months ago, the buy/sell ratio was 38-2.)

The lesson? Being contrary sometimes works -- and it always makes you think. Although AAPL's fundamentals appear sound to many and the company's popular acclaim remains high (see Barron's list of the most-respected companies), the market is telling us that something has changed.

Finally, "hindsight capital" always has 20/20 vision, as The Financial Times notes (log-in required). For a variant view, I humbly suggest considering my 15 Surprises for 2016, which will be published shortly. (Click here to check out last year's 15 Surprises for 2015.)

Lesson No. 10: The Market Has No Memory Have I mentioned that the market has no memory from day to day?

The S&P 500 was down by nearly 40 handles a week ago Friday. Then it was up early last week, but fell by 65 handles last Thursday and Friday. And this morning, S&P futures were at +16 at last check. Res ipsa loquitur.

Another lesson learned is that it pays to trade opportunistically and unemotionally, often leaving your brain and charts at the door. That's due to the outsized role of gamma hedging, risk-parity strategies and other machine/algo strategies in today's markets.

In the meantime, click here to check out my initial top 10 Wall Street lessons, as outlined two weeks ago.

[dougkass]

Icahn Is Wrong About High-Yield ETFs

"It is simple and self-evident (that) the high-yield bond market is just a keg of dynamite that will sooner or later blow up."

-- Carl Icahn, CNBC's Fast Money (Dec. 11, 2015)

Wrong, Carl! It's neither simple nor self-evident!

I believe Icahn is wrong and hyperbolic as a leading voice in warning that high-yield-bond exchange-traded funds represent a systemic risk to our financial system. (See his recent Danger Ahead video for Icahn's thesis.)

I think the mega-investor is materially overstating high-yield ETFs' influence on the market -- and that they don't represent a systemic threat. 

Consider:

The Market Is Small

High-yield ETFs represent a very small percentage of total assets under management for high-yield bonds. Icahn is crediting them with more influence than they really have.

Size Matters

The list of high-yield ETFs with assets over $2 billion is short. There are only four -- the $15.2 billion iShares iBoxx $ High Yield Corporate Bond ETF (HYG), $10.1 billion SPDR Barclays Capital High Yield Bond ETF (JNK), the $4.2 billion Senior Loan Portfolio (BKLN) and the $3 billion SPDR Barclays Capital Short Term High Yield Bond ETF (SJNK).

The Market Is Diversified

The largest high-yield-bond ETFs aren't leveraged, but are diversified -- and easily track the high-yield indices. This is in contrast to the troubled Third Avenue Focused Credit Fund, which has a concentrated portfolio of illiquid, "off-the-rack" positions that are virtually unsellable.

Arbs and Market Makers Should Return

Expect arbs and market makers to move in and capitalize on the sector's large net-asset-value discounts.

Until the last few weeks' panic, the volatility of high-yield funds' NAVs had been falling, while fund-flow volatility was rising. This implies a maturing market structure.

As such, there could be a resurfacing of arbitrage once the current panic subsides, reducing NAV discounts. This stabilizing impact of arbs and market makers could offset any fears of retail outflows intensifying and creating further price distortions.

High Volume, No Price Disruption on Friday

Goldman Sachs remarked late last week that the market was handling the record-high junk-bond-ETF volume well -- more evidence of a maturing market structure.

To Goldman, that's a signpost that ETFs' ability to track their underlying NAVs remains intact. As an example, HYG traded 54 million shares on Friday vs. only 7 million on an average day. Although the high-yield market got whacked and less-liquid individual junk bonds suffered, there was no disruption in ETF prices.

Expect Scant Refinancing in the Medium Term

Risks in both the high-yield and leveraged-finance markets appear manageable given companies' maturity profiles. Even CCC-rated issuers have little debt to refinance over the next three years.

Activist Targets?

Should NAV discounts continue to expand, it's conceivable that managers of some smaller junk-bond ETFs might let their portfolios run off and make distributions to shareholders. Alternatively, some funds could become targets of activist investors, who would want to open closed-end high-yield ETFs. (Are you listening, activist Carl Icahn?)

Just look at the $700 million Blackstone/GSO Strategic Credit closed-end fund (BGB). That's a smaller fund that might be an activist candidate considering its current 16% discount to NAV.

This Is High Yield's Worst Non-Recession Year

High-yield spreads have widened by nearly 100 basis points since October's end, with oil, telecom, metals and mining accounting for the lion's share.

However, the widening spreads could conceivably be peaking right now just as investor appetite for risk eases -- and just as Icahn is adding fuel to the junk-bond fire. Much will depend on the outlook for oil prices and global economic growth.

Where Carl is Right

"I believe the meltdown in high yield is just beginning."

-- Carl Icahn on Twitter (Dec. 11, 2015)

Notwithstanding the above, Icahn is probably right is his argument above -- that we're at the end of bubble-era financing.

And in all likelihood, widening investment-grade and high-yield bond spreads will take a toll on equities. Historically, they almost always have.

The consequences of widening spreads have been a continuous subject in my diary for the last year. In fact, they're one of the foundations of my negative market assessment.

Sharply widening spreads likely spell a marked reduction in share buybacks and M&A activity, which companies often finance with investment-grade and high-yield bonds. Hence my Peak Buybacks, Peak Activism and Peak M&A views. Check out my quotes in a Barron's piece that came out over the weekend.

But as for Carl Icahn's investments, his positions in Freeport McMoRan (FCX), Cheniere Energy (LNG) and Chesapeake Energy (CHK) seem terribly wrong-footed.

Last week in a response to a question from CNBC's Scott Wapner, Icahn defended the indefensible by calling those holdings "activist"-inspired -- implying that in some way, their deteriorating end markets were just a sideshow.

But with the benefit of hindsight, Icahn grossly underestimated the deflationary pressures facing commodities (especially energy). He's made large investments in companies that face real and likely sustained operating challenges that no degree of activism will likely remedy.

That's why I'm "Peak Icahn" these days as well. Click here to see the dismal two-year price chart of Icahn Enterprises (IEP), which serves as a holding company for many of Icahn's investments. (Icahn owns 88% of the stock.)

IEP peaked at  $125 a share two years ago, but closed on Friday at $66.

The Bottom Line

In summary, Icahn appears wrong regarding the systemic risk associated with high yield ETFs, partly because the ETF universe simply doesn't represent much in the way of total assets. Still, he's probably is right about the "knock-on" impact that widening junk-bond spreads might have on the U.S. stock market.

I have nothing but the utmost respect for Carl Icahn. In fact, I believe he and Warren Buffett might be the modern era's two greatest investors. But that doesn't prevent me from criticizing the things that either say or the investments that they make when I disagree with them. (I've been openly critical of some of Buffett's moves since 2010).

As for Icahn, some of his largest investments say to me that he doesn't practice what he preaches, or else he never would have made them. He's also gotten the equity class of some of his targets wrong. For instance, Icahn would have ironically been better off buying debt instead of equity with energy/resource companies.

Or maybe Carl should become an activist in the very space that he's critical of: high-yield ETFs. He could probably make more money doing so in 2016!

[dougkass]

Our Bifurcated Market and a Peek at 2016

"Life's but a walking shadow, a poor player That struts and frets his hour upon the stage And then is heard no more. It is a tale Told by an idiot, full of sound and fury, Signifying nothing."

-- William Shakespeare, Macbeth

Last week's market rally was probably meaningless and likely inconclusive, significantly influenced by the manner in which the machines and the algorithms interpreted the headlines.

Gamma-hedging, risk-parity and price-momentum quant strategies have consistently overwhelmed Wall Street and continue to play a commanding role in a market with no memory from day to day.

Stocks still lack the breadth that's typically associated with a sustained uptrend. Despite the S&P 500's 2% rise Friday, equities were only slightly higher for the full week -- with New York Stock Exchange decliners beating advancers nearly 2-to-1.

Large caps are still trumping small caps as Mr. Market remains bifurcated. The winners -- technology, financials and defensive staples -- are beating the pants off of energy, utilities and high-dividend stocks.

On the downside, MLPs were influenced by rising interest rates, lower energy prices and dividend-cut concerns. But at the other extreme, we saw a big upside in gold. (Note: The amount of gold held by the SPDR Gold Shares ETF (GLD) fell nearly 3% Wednesday, which could have represented a capitulation.) 

Jim "El Capitan" Cramer looked extensively at our extremely bifurcated market in his column It Looks A Lot Better Than It Actually Is:

"Underneath, however, the problems are looming, and those problems have to do with the commodity losers that are now bleeding into the mainstream of the credit markets.

The action in Freeport-McMoRan, Kinder Morgan and Chesapeake must not be lost on anyone. They are more important than Action Alerts PLUS portfolio holding Starbucks, Nike and Ross Stores. They can take more hedge funds down and they can't be controlled, because they have to do with the absolute direction of energy and minerals and mining. ...

Now, it is possible to build a significant advance with banks, insurance companies and techs going higher. However, that's a very hard call if utilities, real estate investment trusts, oils, minerals, mining, manufacturing, transports and health care are all rolling over, with a few exceptions. ...

So, despite the better employment, and despite the lower gasoline, and despite the big gains in the averages, I simply still think we are in no man's land or perhaps worse if oil doesn't rally and the dollar starts going back up.

In other words, it looks a heck of a lot better than it is."

The Divine Ms M. (Helene Meisler) also analyzed our narrowing market condition over the weekend in Volatility Will Continue; Just Look at Friday's Divergences:

"Friday had 44 stocks making new highs. Tuesday had more than twice that at 105 stocks making new highs. Worse than that is the fact that Friday had nearly 200 stocks making new lows.

Three weeks ago, on Nov. 13, we had 227 stocks making new lows on the NYSE. The S&P was 70 points lower on Nov. 13.

So once again, ask yourself, if the S&P fell 70 points from here, would there be fewer than 227 stocks making new lows? I'd say unlikely."

The Topping Process Continues

As I mentioned last week, the early December period will be important to the how the market does for the month as a whole (which typically demonstrates seasonal strength).

In a normal market, one would think the year end would bring some bargain hunting in oversold sectors like energy. But as I've consistently written, there's nothing normal about today's market.

As I remarked last week, there are some RSI momentum divergences in market leaders like the TFANGs. I discussed Amazon and Alphabet last week, and now Nike and Facebook are joining the fray.

The Divine Ms. M also commented about these divergences over the weekend, writing:

"Friday's rally was so glaring in terms of divergences I can't imagine everyone didn't see them. And this time it wasn't about the Favored Few. If anyone tells you that Friday was all about the Favored Few , then they aren't paying attention.

Let me just pick on two of the Favored Few for a minute. If Friday was about them, then why was Amazon (AMZN) up less than 1% and Facebook (FB) up less than 2%? In my view, Friday was the inverse of Thursday. It was all about the macro positioning that was caught off guard."

Meanwhile, while confidence has improved a bit, it's still cautious and not overly bullish -- which could argue for a new high in the major market averages, with more optimism creating a "sentiment peak."

Despite consensus expectations at 2015's beginning for an 8% gain for the year, stocks are basically unchanged so far this year. (The Dow Jones Industrial Average has advanced by only 15 points year to date.)

As for bonds, 10-year Treasury yields have risen only nine basis points despite a consensus forecast when the year began of a 75-basis-point gain.

A Peek (and Maybe a Peak) at 2016

Precedents haven't been helpful this year, and they might not be helpful next year, either.

Back in January, numerous technical precedents -- the fact that we were past midterm elections, in the third year of a president's term, the fifth year of a decade, etc. -- all pointed toward a positive year for stocks. But that's not likely to prove correct, at least in terms of where the S&P 500 or other major averages wind up at year's end.  

These precedents might also fail to help in predicting the market's performance in 2016. For example, the notion that a December Federal Reserve "liftoff" and slow rise in interest rates over the next year won't hurt stocks is one precedent/consensus view that might be wrong. Indeed, the old "Three Steps and a Stumble" rule might be a "One Step and a Stumble" rule this time around.

A possible rationale for the upset of such precedents for the second year in a row could be the unprecedented lengthy period of 0% interest rates we've seen from central bankers around the world.

If you seem confused by all of this, you're not alone! Stay tuned.

[dougkass]

Wall Street's Top 10 Lessons

Here are the 10 biggest things we learned from last week’s Wall Street action:

1. In a market dominated by momentum-based algorithms, buyers live higher and sellers live lower. With price swings exaggerated by computer trading, the value of charts and technical analysis have lost some relevance.

2. As a result, the market has no memory from day to day.

3. Risk happens fast.

4. As David Tepper said two months ago on CNBC -- when the flow changes, disruptions and bad things often happen. Note: The flow is changing.

5. Whoever thinks the market hasn't advanced since 2012 to a large degree thanks to Federal Reserve largesse is loco.

6. Ignore the business TV "talking heads" who are self-confident and glib in view. They don't recognize that we live in a world where the only certainty is a lack of certainty (and they're probably trying to sell you something). There's no "secret sauce" on Wall Street.

7. We're not nearly as safe as investors and citizens as markets presume.

8. Our dependence on central planners and central bankers represents a slippery slope for markets and global economic growth. Planners and bankers are human and often make mistakes, particularly in forecasting.

9. A period of substandard global economic growth likely lies ahead. As such, worldwide growth is more susceptible to a "black swan," or even "baby swan" events.

10. A period of substandard investment returns could also lie ahead.

[dougkass]

The Consensus Was Wrong: Cheap Oil Hurts

Lower oil prices are "certainly good for families, for households. It's putting more money in their pockets." -- Fed chair Janet Yellen, December 2014

This year started with a strong consensus view, as expressed in Janet Yellen's comments above, that lower oil prices would serve almost like a massive tax cut for consumers, boosting the economy and stimulating corporate profits.

Oil vey! Were they wrong!

Consider:

A year ago, consensus 2015 earnings-per-share forecasts for the S&P 500 were above $130 a share. Now, the consensus is about $113. A good portion of that decline stems from reduced expectations for the energy sector, which other sectors haven't offset.

Retail spending disappointed throughout 2015. Indeed, the retail sector has been a market landmine this year. Just look at what's happened to the earnings of Ralph Lauren (RL), Macy's (M), Bed Bath & Beyond (BBBY), Wal-Mart (WMT), and nowCostco (COST).

The BRICs (Brazil, Russia, India and China) are suffering from lower commodities prices, including oil. And they've have "exported" the resulting deflation, slowing economic growth and reduced profits.

In a flat, networked and interconnected globe, We are the World. We're not an island of prosperity -- lower energy prices have caused a slowdown in world trade, and global economic growth has suffered.

The transportation industry and U.S. port activity have both floundered as energy-related activity waned.

Lower prices for energy and other commodities have caused global political turmoil, and have contributed to Mideast instability and rising geopolitical risks.

The U.S. energy sector is suffering much worse than expected, as measured by unemployment, activity and profits.

There has been much more collateral damage from lower oil than many predicted. Most importantly, the high-yield-bond market has fallen its lowest price since the 2011 European financial crisis under the weight of lower energy credits.

Lower oil prices have wrecked havoc and caused many billions of dollars in losses to energy-related investments like MLPs and stocks of exploration-and-production companies.

Airlines were supposed to be one beneficiary of lower oil prices, but shares ofSouthwest Airlines (LUV) dropped by 10% yesterday -- the worst performance among S&P 500 components. LUV tanked after the firm warned that operating revenue per available seat will likely fall this quarter.  

As I begin to assemble my "15 Surprises for 2016" list, I want to focus on one of the most successful surprises that I highlighted for 2015.

It's been my long-held view that an energy-price drop wouldn't help U.S. corporate profits or global economic growth on balance. 

Here is, in its entirety, my forecast from April on how lower energy prices would have an ambiguous impact in 2015 -- 15 Surprises for 2015:

"Ambigious Oil

On Fast Money Halftime my friend/buddy/pal BTIG's Dan Greenhaus remarked that ex-energy 1Q 2015 profits will be up slightly year over year.

I agree with Dan.

But wasn't the consensus view that the collapse in oil prices would add to corporate profitability, especially when petroleum products serve as raw materials?

So shouldn't that modest improvement in non-energy corporate profits be seen as DISAPPOINTING?

And I would add, strategists didn't adjust S&P profits when oil was $110 a barrel, did they?

One of my Surprises for 2015 was that the much-lower-price of oil would not have an incremental positive impact on the domestic economic recovery this year.

Here is my outlier view on the relationship between economic growth and oil prices:

Despite a nearly universal view that oil prices will be a net benefit to the U.S. economy, I continue to believe that the benefit remains ambiguous. Retail spending and overall economic activity remain subdued, despite lower oil prices.

Two weeks ago, Peter Boockvar wrote this:

February retail sales ex gasoline and volatile auto's unexpectedly fell by .2%, well worse than expectations of up .3% and January was revised down by three tenths. The 'control group' sales, which also takes out building materials, saw no growth m/o/m and January was revised down by two tenths. The estimate was up .4%. Sales fell m/o/m for autos, furniture, electronics, building materials, health/personal care, department stores and restaurant/bars. Gains were seen for online retailers, sporting goods and food/beverages. Sales of clothing were flat after two months of declines and thus haven't grown since November. Bottom line, sales ex gasoline station sales on an absolute basis are at the lowest level since September. The belief that lower gasoline prices (down 30% y/o/y) were going to spur a large pick up in spending on other goods just hasn't happened. It's been saved, used to pay down debt, used for higher food and rent or property tax costs (to name a few higher costs of living) and possibly is being spent on services, such as healthcare (thanks to Obamacare) which has been the biggest source of growth in services spending. I'm not going to use weather as an excuse as its winter and the data is seasonally adjusted. Retail stocks are trading at near all time record highs but we've now seen three months in a row of disappointing retail sales as measured by this report. If retail stocks are looking forward, then hopefully they see quicker wage growth coming soon.

A month ago, I continued to question the benefits of lower oil prices.

I have argued that the net benefit of much lower prices for energy products is ambiguous.

We see this in the weakness in certain regional manufacturing data (e.g., the Dallas Fed's manufacturing index), in the rig count contraction, in the jobs market (e.g., job count and wages) in energy dependent states, in stagnating housing activity, in a plunge in energy-related capital spending,  in a weakening high-yield market, and in a (likely) meaningful subtraction ($5/share to $7/share) in 2015 S&P forecasts.

We have yet to see the benefit of lower oil prices in retail spending or in automobile industry sales.

If lower oil and gas prices are anticipated to catalyze domestic economic growth, why is the yield on the 10 year U.S. note still around 1.75%?

And we have yet to see the exposure of commodity-linked notes in the financial community.

The entirety of the Sell Side on Wall Street as well as the Buy Side keep telling us low oil price is good for the economy (and by abstraction earnings and the stock market). BUT the market rips every time market blips up (the last two days), and sells off when the price of oil goes down.

The lesson: Watch what they do, not what they say!

Lower oil prices, negatively impacting economic growth in the U.S.? Inconceivable!

Here you go:

Surprise No. 3 -- The drop in oil prices fails to help the economy.

"In its November 14, 2014 Daily Observations ("The Implications of $75 Oil for the US Economy"), the highly respected hedge fund Bridgewater Associates, LP confirmed that lower oil prices will have a negative impact on the economy. After an initial transitory positive impact on GDP, Bridgewater explains that lower oil investment and production will lead to a drag on real growth of 0.5% of GDP. The firm noted that over the past few years, oil production and investment have been adding about 0.5% to nominal GDP growth but that if oil levels out at $75 per barrel, this would shift to something like -0.7% over the next year, creating a material hit to income growth of 1-1.5%." -- Mike Lewitt, The Credit Strategist

Despite the near-universal view that lower oil prices will benefit the economy, the reverse turns out to be the case in 2015 as the economy as a whole may not have more money -- it might have less money.

Continued higher costs for food, rent, insurance, education, etc. eat up the benefit of lower oil prices. Some of the savings from lower oil is saved by the consumer who is frightened by slowing domestic growth, a slowdown in job creation and a deceleration in the rate of growth in wages and salaries.

And the unfavorable drain on oil-related capital spending and lower-employment levels serve to further drain the benefits of lower gasoline and heating oil prices.

In The Financial Times, recently, Martin Wolf wrote: "(A) $40 fall in the price of oil represents a shift of roughly $1.3 trillion (close to 2 per cent of world gross output) from producers to consumers annually. This is significant. Since, on balance, consumers are also more likely to spend quickly than producers, this should generate a modest boost to world demand."

But Wolf, and the many other observers, as Mike Lewitt again reminds us, "fail to explain how the $1.3 trillion that has been deducted from the global economy is able to shift from one group to another."

I will stick to my thesis.

My buddy/pal/friend Byron Wien of Blackstone offers an opposite view to mine on the ramifications of lower oil prices."

-- Doug's Daily Diary, Ambiguous Oil (April 2, 2015)

[dougkass]

The Unplayable Market

The S&P 500 lost 23 points Wednesday erasing the gains from the prior day.

I'm repeating an earlier missive in full, as it cautions that this is not your father's market. Rather, it's a random walk -- and nearly unplayable from day to day unless you're very fleet of foot.

These spastic daily market moves are in a large part governed by quant strategies that are agnostic to underlying values and have partly invalidated the interpretation of price charts and trends. They've also rendered technical analysis far less valuable than it was in the past.

From December 2, Doug's Daily Diary, A Market Without Memory from Day to Day:

"As I discussed in a recent speech in New Orleans, many are misinterpreting daily market swings as a real price trend that they can interpret technically.

But I see that as incorrect, as gamma hedging, risk-parity strategies and other quant actions have ruined our markets.

In fact, I think these trends have negated not only some of the value of stock charts, but to some degree the value of technical analysis in general. This places many market participants in the position of having a false sense of security.

As I've previously written:

'We live in a dystopian investment world, whose markets have morphed into an Orwellian backdrop of omnipresent government intervention and manipulation that is increasingly dictated by the quant community -- who worship at the altar of prices and price momentum (and are agnostic on values).'

'To understand that risk, we have to wrestle with the investment strategies that few of us see but all of us feel ... strategies that traffic in the invisible threads of the market, like volatility and correlation and other derivative dimensions.'

'Regardless of what the Fed does or doesn't do, regardless of how, when or if a 'lift-off' in rates occurs -- it is impossible to ignore derivative market dimensions and the vast sums of capital that flow along these dimensions.'

'Remember, price trend following strategies, risk-parity portfolios and volatility-managed strategies based solely on past price performance and volatility. They are agnostic to company balance sheets and income statements. Intrinsic value is not in their vocabulary -- fundamental investors like Warren Buffett are an anathema to them. But they are far more dangerous than portfolio insurance, which put an exclamation point in the 1987 market crash.'

As we saw on the downside at September's end, there's a positive feedback loop between all of these strategies. Gamma hedging of derivatives caused higher market volatility, which in turn led to selling in risk-parity portfolios -- and the resulting downward price action invited further shorting by price-trend strategies.

And more recently, we've seen this feedback loop to the upside.

No wonder financial asset prices seem to no longer correlate with the real economy. This is a market with no memory from day to day."

[dougkass]

The Calm Before the Storm?

"Someone told me long ago There's a calm before the storm, I know; it's been comin' for some time. When it's over, so they say, it'll rain a sunny day, I know; shinin' down like water."

-- Creedence Clearwater Revival, Have You Ever Seen the Rain?

If you think that this rally is picture perfect, I have a bridge to sell you in Brooklyn.

Economic news and corporate profits matter, and so does market breadth. Healthy bull markets have broad participation, but unhealthy ones have narrowing participation.

Here's a look at both the technical and fundamental issues that I see facing the market:

The Technicals: The Rally Has Bad Breadth

The best gauges of market breadth are the advance/decline line and the number of stocks hitting new 52-week highs. 

Strong bull markets exhibit bold cumulative advance/decline lines and expanding 52-week highs, which confirm the highs reached in the broad indices (where large-capitalization stocks dominate). But weak bull markets show breadth that diverges from the big indices on these two measures, failing to confirm the new highs.

To measure this accurately, analysts often look at the relationship between an index's equal-weighted and capitalization-weighted versions. A rising relative line between the two denotes a healthy market, while a declining line means a few large-cap stocks are driving the advance.

This year, the New York Stock Exchange's common-stock-only advance/decline line peaked in May and lagged during the market's recovery from late-September lows.

Moreover, new NYSE 52-week lows have eclipsed new 52-week new highs for some time, as you can in the chart below (which is a bit small, but shows new lows in purple and low highs in black). This is a signpost of underlying weakness:

We can also clearly see a declining trend if we compare the S&P 500's equal-weighted and cap-weighted versions. This shows that the index's large-cap components have outperforming their smaller brethren since mid-April -- and remarkably, still made new lows in the face of a 12% recovery in the overall S&P 500:

This raises the question of whether investors should chase the TFANGs or the NOSH -- Nike, O'Reilly Automotive, Starbucks and Home Depot. These stocks could eventually get defanged because the rest of the market might be unusually vulnerable to a correction.

Large-cap quality holdings might work for a longer time. But without support from the majority of lesser stocks, attrition seems likely to eventually take a toll on the market's current leaders. As the old saying about Wall Street's traditional "Santa Claus Rally" goes: "If Santa Claus should fail to call, bears may come to Broad & Wall."

The Fundamentals:  Good News is Great, Bad News Is Even Better?

The fundamental front shows concerns about punk domestic economic data, as seen in weak retail sales, a manufacturing contraction and a possible peak in housing and autos. We also see the prospects for moderating operating profits, slowing Chinese and Eurozone growth rates and a new multiyear low in high-yield bond prices.

On that last point, high-yield bonds are definitely acting "junky." This chart amplifies just how significantly weak the sector has been this year:

CCC-rated bonds have underperformed BBs over the last 12 months by 700 basis points (and by over 450 basis points ex-energy). There are only three previous instances of such deep underperformance. Two coincide with the mature credit cycles of early 2000 and early 2008 and one was a "false positive" in late 2011.

On the point of slowing global economic growth, Goldman Sachs recently opined that the U.S. economy's natural state has deteriorated from the past and "will remain lower for longer." Indeed, some seven years of monetary easing have served to weaken the economy to the point where secular-growth prospects might be nearly half of what we experienced over the last three to five decades.

Deutsche Bank goes one step further, arguing that after decades of bubbles, reducing the equilibrium real rate of federal funds serves as a negative to growth:

"The real case for policy error -- equilibrium short real rates may be below zero. There are two interpretations of the macroeconomic data that have vastly different implications for the effect of imminent rate hikes. The first is the 'conventional' view, which the Fed subscribes to. This view posits that the short-term real equilibrium rate is around zero. Since the nominal funds rate is at the zero lower bound, policy is accommodative, and this is why the labor market has improved rapidly. Inflation has not picked up because it as a lagging indicator. ...

The alternative view is more worrying. In this view, the equilibrium nominal rate is at present much lower than the Fed thinks, and the equilibrium real rate is meaningfully negative. Policy at present is not very accommodative, and to the extent that it is, inflation is actually running above its equilibrium level, which is close to 1%. ...

This is the important policy-error scenario, because even a very shallow path of rate hikes might drive the real fed funds rate well above the short-term equilibrium real rate, further depressing demand. It is then plausible that the economy would be driven into recession, and the Fed would quickly be forced to abort the hiking cycle." 

-- Dominic Konstam, Deutsche Bank

Moreover, there is simply too much debt. Unconventional monetary policy simply expands the debt load and  makes the U.S. economy extremely vulnerable to an interest-rate hike. So, the Fed is trapped.

Meanwhile, the conspicuous flattening in the yield curve is another possible signpost of slowing domestic economic growth and/or a Fed policy error:

Source: Zero Hedge

The Calm Before the Storm

The bottom line: The "Ah-Ha" Moment, where investors lose faith in central bankers, might be ever closer at hand. Both the technicals and fundamentals are conspiring to form a possible toxic market cocktail.

Be alert to foul weather ahead. As Creedence Clearwater Revival once sang: "Sun is Cold and Rain is Hard."

[dougkass]

What I Expect Following the Paris Attacks

French President Francois Hollande, following this weekend's Paris terror attacks:

"(This attack was) against France, against the values that we defend everywhere in the world, against what we are: a free country that means something to the entire planet. (France will respond using) all the necessary means and on all terrains, inside and outside, in coordination with our allies, who are, themselves, targeted by the terrorist threat."

Friday's terrorist attacks complicate the market picture, but I don't agree with the consensus that emerged over the weekend that stocks will fall hard in reaction to the event.

Remember, Paris was already shaken less than a year ago by the January attacks on magazine Charlie Hebdo and a kosher supermarket. That prompted a period of soul searching about France's secular values, as well as antiterror legislation designed to help authorities better prevent attacks.

January's incident targeted specific entities (French Jews and a satiric magazine that ran cartoons depicting the Prophet Muhammad). But Friday's attack seems intended to make French citizens feel that they're not safe anywhere, striking people involved in ordinary activities.

Perhaps the terrorists selected their latest targets -- a sports event, a popular restaurant and a music venue (known to have been a frequent meeting place for Jewish organizations) -- because each involve pleasures not allowed in the Islamic State of Iraq and Syria.

ISIS has claimed responsibility for the attack, as well for the recent downing of the Russian passenger jet. There's still much that's not known about the latest incident, but the French response has been swift and purposeful. The known terrorists are dead and France has declared a nationwide state of emergency, imposed border checks and put its army in control of protecting Paris.

"An armed attack against one or more of them in Europe or North America should be considered at attack against them all." -- Article 5 of the North Atlantic Treaty Organization charter

It's now clear to most people that the time for passivity has passed and that that we need a "roadmap" and robust response to terrorism. These responses could, in theory, have a salutary impact on stocks over time.

My take:

France's Likely Response I view Friday's attacks as France's 9/11. I expect the attack to harden the French people's resolve against ISIS. A major and continuing military initiative by France against ISIS targets seems probable.

America's Likely Response To merely say that ISIS will be defeated -- as the Obama administration has done until recently -- isn't enough. (I would note that Hillary Clinton seemed to take a more-aggressive stance than President Obama in Saturday's Democratic presidential debate, essentially saying that America shouldn't see ISIS as a junior-varsity team.)

Words have little meaning to terrorists; actions do. I'm hopeful that Obama and both the Republican and Democratic presidential candidates will articulate plans for eliminating ISIS.

This could include major changes in U.S. and European Union immigration laws. That said, the U.S. situation is fundamentally superior to the problems facing Europe. While the EU's "Schengen rules" allow for easy travel within European Union borders, there are more serious roadblocks in our country.

America also spends more than $45 billion a year on homeland security ($650 billion since 9/11). By contrast, Germany spends only $660 million annually on its entire intelligence effort, and France only recently adopted a $786 million multiyear effort to combat terrorism.

NATO's Response I expect the NATO alliance and others to launch a coordinated, massive ground assault on ISIS. I predict forces will attempt to eliminate ISIS's stronghold in Iraq and Syria. Diplomats will also place pressure on regional powers (particularly Saudi Arabia) to participate in these efforts.

The Muslim World's Response A sustained and unified response now likely lies ahead, but the battle will be long and only truly won from within -- by the hundreds of millions of Muslims who are peaceful and disgusted with what happened in Paris. They, too, must raise their voices and be committed to act against ISIS in unambiguous and sustained unison.

The Economy's Response I don't expect the Paris attacks to have any sustained impact on commerce or trade.

The Federal Reserve's Response Coupled with the Paris attack, recent weak U.S. economic data could prompt the Fed to shifting the rate hike widely expected for its December meeting into 2016 instead.

[dougkass]

It Still Looks Like Wall Street Topped in May

French President Francois Hollande, following Friday's Paris terrorist attacks: "We are going to wage a war that will be pitiless."

I shared my views over the weekend about the terrible events in Paris, writing in Doug's Daily Diary, The Constant Risk of Terror (Nov. 14, 2015):

"The horrific events of the past 24 hours speak for themselves. Terrorism -- like the horror we experienced 14 years ago on Sept. 11 -- cannot be measured or quantified in market or economic reactions; it is simply a troubling reminder of a constant risk to a civilized society.

Unfortunately, this is the 'new normal.' There is a sense of hopelessness that has descended over Paris and the rest of the free world.

On a more personal level, Friday's horrible events opened wounds that I have shared with all of you before (and that many others have suffered, too) in the loss of Chuck "Brown Bear" Zion to al-Qaeda in 2001. It makes me sick beyond measure." 

Without being disrespectful to those the Paris attacks impacted, I'll be sharing my take this morning on what the incident will likely mean for investors. 

To begin with:

The horror in Paris complicates the picture for Wall Street.

I don't expect a meaningfully adverse response by global equity markets to the awful terrorist attack. Indeed, it's not entirely out of the question for stocks to trade higher over the next few days in response to the attacks, which could galvanize the world's resolve against terrorism.

I am back to market neutral.

Factually, 2015 has been a year in which:

Large-cap stocks have outperformed small-cap ones.

Growth stocks have outperformed the cyclical sectors.

Developed markets have outperformed emerging ones.

Investment-grade debt has outperformed the high-yield market (i.e., "junk" bonds).

Most importantly, I remain of the view that Wall Street established an important market top back in May, and that most equities are transitioning from a six-year bull market into either a bear market or a meaningful, extended correction.

But unlike market bottoms, market tops usually involve a process -- with tests to both the upside and downside, as we've witnessed so far this year. And in the late stages, the topping process usually sees the market's "generals" holding up (like the TFANGs), while the "soldiers" are wounded (or worse). That's been the case so far this year.

Alphabet, Amazon and Facebook have all been the standouts, but even they began to show signs of some wear and tear late last week. If you look closely at the three stocks' charts, the recent price action appears to look more like "exhaustion gaps" than the beginning of a new up leg. (And if the recent gaps get filled, I'll be even more confident of that.)

Amazon's rally recently moved founder Jeff Bezos up to the No. 4 slot among the world's richest people. Such headlines -- like the ones we saw in 1999 when a Microsoft rally made Bill Gates the world's richest person --- usually occur at major market tops.

As for the "apple of everyone's eye," Apple has continued to underperform its growth brethren since hitting a May high. While it briefly experienced strength in the October rally, that proved short-lived.

Finally, the number of large-cap leaders is narrowing vs. what we saw in previous 2015 rallies. For example, leadership in health care has fizzled.

On the other hand, we've been seeing weakness in industrial stocks and basic materials (which involve depressed commodities). However, this group has begun to experience improving relative performance, with most stocks trading above their late-August lows. And in the case of the energy sector, stocks are trading far better than the underlying commodity (oil prices hit another new low on Friday).

Turning to the fixed-income markets, the high-yield markets continue to look "junky." This sector remains in a well-defined downtrend and is now threatening its September lows. But as I've written previously, a weak high-yield market has historically led to equity-market declines.

In summary, the technical conditions are pointing to market weakness ahead.

I'll share some deeper thoughts about the markets and the Paris attacks shortly.