«The market is vulnerable to a correction»
Blackstone’s market maven Byron Wien warns that stocks are in danger of suffering a setback. But he also explains why investors should keep their calm and weather the impending storm.
To expect the unexpected is the key to success in investing. That’s exactly what Byron Wien has built himself a unique reputation on: For more than thirty years the living Wall Street legend publishes a yearly list with ten surprises that will have a meaningful impact on the global financial markets.
«People all over the world are aware of it and identify me with it», says the Vice Chairman in the private wealth group of Blackstone. «What they seem to like about it is that I put myself at risk by going on record and hold myself accountable at the year end», he adds.
So how accurate are Wien’s predictions for 2017 so far? Which developments could surprise investors during the rest of the year? And first and foremost: Where does the experienced market maven see the biggest risks and opportunities right now?
Mr. Wien, everybody on Wall Street knows you for your yearly prediction of ten surprises. What is for you personally the most astonishing development so far this year? - I would say I’m having an average year where I get five or six surprises right. Everybody calls them forecasts or predictions but they really are surprises. To me, a surprise is an event that the average investor would only assign a one out of three chance of taking place but which I believe has a better than 50% likelihood of happening. I never get them all right but I don’t do it for score. I do it to get people thinking.
Which surprises did you get right so far? - I said that the S&P 500 would go to 2500 this year. It’s close to 2480 now and we are at the end of July. So I’m pretty optimistic about that one. I also said the price of oil would be lower than people thought and it is lower than people thought. So those are some of the highlights.
And what took you by surprise? - The drop in interest rates and the weakness of the dollar were the big surprises to me. I said interest rates would rise and they fell and I said the dollar would be strong and it’s been weak. So I definitely got those two wrong. The same is true for Donald Trump. I said correctly that he would soften his positions and he has reversed himself on a number of issues. But I didn’t think he would get so little done. So far he has gotten nothing done, nothing to show for. He spends way too much time on Twitter and he hasn’t even gotten the affordable care act revised. That’s a disappointment.
What’s next for the Trump agenda? Does his plan for a “huge” tax reform still stand a chance? - I think he will get it done. But as time goes by it’s threatening. If the Republicans don’t get an important part of the Trump agenda passed they could lose a lot of seats in the November 2018 elections. So this is the big risk the party is facing. Also, Trump has been very insular in his approach. He hasn’t reached out to Democrats and I don’t think he’s even solidified his own party. He spends most of his time with his own staff and his family but you don’t see him going out or having Congress people in for dinner or things like that. So here we have a guy who is president and who has control of Congress. But to get anything major done he needs 60 votes in the Senate and he’s barely getting 50 because there is anarchy in the Republican party.
The original plan of the Republicans was that the spending cuts from repealing and replacing Obamacare would help finance the tax reform. Are significant tax cuts still possible? - The United States is already running a $560 billion tax deficit. By my calculation, if Trump gets his tax reform through it will double the size of the deficit from around $500 billion to one trillion dollars. That is still not a disaster. The US is a $20 trillion economy. So a 5% deficit is not the end of the world.
So far the markets are taking Trumps inability quite lightly. How long will that last? - Donald Trump is a lucky guy. He is lucky because earnings are coming through better-than-expected. If the market was going down that would be trouble for him. But the market isn’t going down. So Trump has done almost nothing right and the market is up. He’s getting away with something.
What’s your take on the state of the stock market in general? - There are some wild cards out there: North Korea, the risk of Russia invading the Baltics and the Trump administration continuing to be in chaos. Those are negatives. But overall, the tone of the market is favorable and earnings are coming through better than expected. Investors are optimistic and everybody on Wall Street is having a good year. But in the real world out there most people are not doing so well. For example, the University of Michigan Consumer Sentiment Index is at a nine month low. Even though the employment numbers are good, average hourly earnings are only increasing at a rate of 2.5%. So wages aren’t increasing and that’s what is dampening consumer sentiment.
What’s your explanation for this discrepancy between Wall Street and Main Street? - The earnings of US corporations are increasing and that’s driving the stock market. Companies are doing everything possible to increase profitability. Also, there’s a certain amount of financial engineering going on. Many companies are using the cash on their balance sheet to buy their own shares back and to pay higher dividends.
What’s also remarkable is the quiet in the market. For instance, the VIX volatility index is hovering around the lowest level since 1993. - Don’t spend a minute thinking about volatility. I encourage people around here at Blackstone not to use volatility as a predictive indicator. It was useful in the past but it isn’t useful now.
Why? - We never had algorithmic trading playing such an important role as we have now and that has really dampened volatility. Many of these trading programs are based on the assumption that prices and returns eventually move back toward the mean or average. So nothing is getting out of line. That’s why I just don’t think volatility is a good indicator. Often times, people equate volatility with risk. But volatility is a variation in price and it isn’t risk. Risk is losing money.
So where do you spot the biggest risk right now? - There are two things I’m worried about. One is the a lack of productivity. There was good productivity improvement in the period from 1995 to 2005 because of the internet. But since then there have been no major innovations and productivity has been disappointing for a decade. The next big productivity booster will be the driverless car and the driverless truck. But that’s several years away. So we will continue to have low productivity.
And what’s the second thing you’re worried about? - Central bank liquidity has been an important factor driving the market. But now, the Federal Reserve is tightening. They have already tightened twice this year and they are talking about shrinking the balance sheet, starting in September. Also, the European Central Bank is talking about being less accommodative as well. So we’re going from a very accommodative monetary policy around the world to a more restrictive policy and that’s going to put a damper on the market.
But if monetary policy is getting less easy isn’t that also an encouraging sign that central bankers are having more confidence in the resilience of the economy? - The Federal Reserve has two mandates: low inflation and full employment. Right now we have full employment and low inflation. So the Federal Reserve is doing its job. They are achieving their mandate and the economy is not overheating. They have no reason to raise rates. But the Fed has allowed its balance sheet to growth significantly. Since the creation of the Federal Reserve it took 95 years to growth the balance sheet to $1 trillion. But because the banking system was in danger of melting down in 2008 they went to $2.5 trillion basically overnight and now they’re at $4.5 trillion. So the Fed feels guilty that it has expanded money too fast and they feel they have to shrink the balance sheet back.
What does that mean for the markets? - The Fed will shrink the balance sheet by letting the treasury bonds and the mortgage backed securities that are on its balance sheet mature and redeeming them. But that will take money out of the system and that’s very dangerous for the markets.
Why? - There is a significant congruence between the expansion of the Fed’s Balance sheet and the performance of the S&P 500. They are roughly congruent except for now because the market is running ahead of the Fed’s balance sheet. That makes me worried of a kind of Wile E. Coyote-Phenomenon where the market is running off the edge of the cliff and it doesn’t know it doesn’t have any land below it to support it. In this case, the missing ground would be the withdrawal of money from the system because not only is the Fed thinking about doing it but the European Central Bank is thinking about doing it as well. So naturally, the market is vulnerable to a 10% correction at any time.
Could that mean the end of the bull market? - I emphasize a correction, not a bear market. I don’t think a bear market is in store. The only thing that really creates sharp downturns is a recession and I don’t see a recession before 2019.
What makes you confident about the economy? - Recessions are created out of excesses: aggressive Fed tightening, an inverted yield curve, building up of inventories, rising unemployment or rising inflation. You don’t have any of those things in place. You could say the stock market is too expensive right now but markets usually don’t tank significantly unless the fundamentals are deteriorating.
What do your recommend investors to do in this environment? - We may experience a summer correction but I’m encouraging investors to be patient and to weather it because the longer-term prospects remain favorable. The earnings for the S&P 500 were originally projected this year to come in at $125. But now, they’re going to be over $130 and I think in two years they could rise to 150 $. So even though the market may look a little bit expensive today, based on earnings, a couple of years from now stocks look attractive. That’s why I’m basically positive and I think it’s going to be worth it to hang in there if a downdraft occurs.
Where do you see the most attractive opportunities right now? - I like the US but I like Europe more and I like Japan the most. The Japanese economy is growing at an annual rate of 1.5%, inflation is at 1%, corporate profits are robust and valuations are lower than they are in the US and in Europe. But most importantly: nobody owns Japanese stocks. When I visit our clients and I look at their portfolios, everybody owns US stocks and people are more fully invested in Europe but basically nobody owns Japanese equities. So if you find a situation that’s improving and it’s not widely owned and it’s undervalued that’s an opportunity.
And what sectors do you favor? - I like companies where the earnings are unpredictable on the upside. For instance, in the US I like companies in information technology and in biotechnology. There’s a reason why Facebook, Amazon, Apple, Netflix, Microsoft and Google are doing so well. They have open-ended earnings, a very high return on equity and they dominate their respective fields. Amazon for example has been able to build a terrific business using technology. The company has around 340,000 employees and a market value of close to $500 billion. In contrast, Wal-Mart has 2.3 million employees and a market value of only $240 billion. Wal-Mart has built terrific business, too, but it’s more of a service oriented company and therefore its horizons have to be more limited.
In which sectors would you rather not be? - The yield on the ten year treasury note is 2.3% now and I think it’s going to get above 3% sometime next year. So I wouldn’t touch anything that’s related to interest rates unless it would benefit from rising rates like stocks of banks and financial institutions. But I wouldn’t touch utilities and telecoms or anything like that.
Would you allow a personal question at the end of this interview? You’ve been working more than fifty years on Wall Street. What’s the most important lesson you’ve learned during your successful career? - When I was offered the Job to be the investment strategist of Morgan Stanley many people said to me: “you have no idea whether you are going to be successful in that job.” Working as a portfolio manager at that time, it also meant that I would have to take a severe pay cut. But I have always wanted to have a job where I could write and where I could travel to places I have never been. So in spite of other people’s advice I took the job and it did make me happier than I have ever been. That’s why my advice is to take a risk. You won’t be successful all the time. But you won’t get anywhere where you want to be without taking a risk.
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