“The future is already here – it’s just not very evenly distributed.”
– William Gibson, Hall of Fame science fiction writer
Since I began writing this letter some 15 years ago, I’ve always done an annual forecast letter, generally in the first week of January. That letter is typically the most-read issue of the year, and I spend more time thinking about it than any other letter. I typically take the last week of the year off from writing just to concentrate on my research, and I often begin to compile my reading material the first week in December, which the calendar tells us is now. Helping me this year will be my associate Worth Wray and a few members of the Mauldin Economics team, and of course my many friends and readers.
This year I’m going to open up a little bit about the process of how I actually write a forecast issue. First off, I am not a model-driven guy. Over the years, I’ve come to have access to a rather amazing array of researchers and analysts who do deep dives on their particular topics, and their models are far more complex than anything I could create. I also make a point of reading conflicting viewpoints, especiallythose of people I know to be smart but whom I disagree with. If I can’t figure out why they’re wrong, then maybe I have to change my mind.
I take all of those models about different segments of the world and try to figure out how they fit together. Admittedly, that exercise involves a great deal more art than science. (And speaking of art, this letter will print a bit longer because there are lots of graphs at the end.)
One of the advantages I have is that when I encounter two or more conflicting opinions I can often pick up the phone and simply discuss the topic with the various authors to see if I can come to some clarity. Sometimes the most instructive things I can learn are the reasons why two very smart people disagree. I have learned over time that there is not as much black and white in economics as one would hope. There are lots of nuances and hidden connections within the global economy that are not obvious to the casual observer. The effort to understand requires me to absorb and distill the massive amounts of information I encounter – while constantly being aware of the biases, assumptions, and basic presuppositions of other writers.
Finally, it’s never just about economics, because history, geopolitics, and psychology are always part of the mix. I simply try to read and view everything I can, a far wider variety of material than most economic commentators tackle, and then choose the path that makes the most sense to me as a forecast.
I tend to be more macro-oriented than market-oriented, but I do at least attempt some market forecasts (if only to demonstrate how futile they are, at least in the short term). In general, I find that macro events eventually lead markets. This approach makes timing rough if you’re a short-term trader, but for those with a longer perspective the macro-driven view adds a great deal of value.
For the next two letters we’re going to look at the issues I’m researching as we approach the end of the year. No deep dives but just a general discussion of the topics and questions we should be thinking about. Of course, we’ll look at tail-risk events. What could go wrong? But we also have to ask ourselves the opposite question: what could go right? What might get even better? I can list several major countries where I think things will get structurally better in the short to medium term, and I’m optimistic about the future of numerous industries.
The research shows, and I’ve done letters about this, that being too negative is actually more harmful than being too positive. Cautious optimism is generally the most rewarding path. But you have to have a large dose of reality. If you live in Japan, the prospect for your currency is markedly different than if you live in Mexico or Norway (more on that later).
But before we begin the letter, let me briefly note that I will be doing a webinar with my friends Ian Bremmer and Jack Rivkin next Tuesday at 1:00 p.m. EST. We will be getting a sneak preview of Ian’s 2015 geopolitical forecast and Jack’s seasoned perspective (that’s a polite way of saying he’s been doing this for over 40 years) on implications for the markets. It’ll be a fascinating 30 to 40 minutes. You can find out how to listen at the end of the letter. Now let’s jump in.
2015 may be the year that macroeconomics really becomes interesting again, if it hasn’t already. After a long period of relatively coordinated central bank policies and remarkably low volatility, the macro scene is becoming more dynamic. That’s great for those who live and die by dramatic long-term shifts in global markets, but it should be terrifying for emerging-market policymakers, currency carry traders, Texas oil men, and, frankly, the average investor. King Volatility is back on his throne.
A LOT can go wrong in this kind of environment, and traditional portfolio design (sloppy combinations of active managers in a 60/40, 70/30, or 80/20 framework) will simply not let you weather a major economic storm. Think 2008. Think 1937. Think 1998 if LTCM hadn’t been dealt with and banks and nations around the world had been a lot more levered – as they are today. The potentials for disruption are enormous, and not just for markets.
Let’s start with a general list of topics.
- The United States seems to be doing relatively well. Employment continues to improve at a 2% pace, more or less; GDP growth is more stable; and interest rates are likely to be low for some time. The equity markets are shrugging off anything negative. You can make a very reasonable case that this climate will continue for another year, so you have to start asking yourself, “What could go wrong?” On my short list is a potentially sharp reduction in capital expenditures in the oil extraction industry. Then US exports are hit by the rising dollar, which also hurts corporate profits of large internationals, which impacts stock market valuations – developments that have historically signaled a major short-term top. And we really need to think through the deflation equation, as energy prices will lower the inflation indexes.
- On the global level, there is the real possibility of a significant US dollar breakout and the unwinding of the US-dollar-funded carry trade. The policy divergence among the major central banks is on the verge of being very pronounced. That will have a far bigger impact on global markets than most of us understand. Such a divergence has traditionally not been good for emerging markets. Ironically, we also have to look at the possibility that the increased funding of global trade in Chinese renminbi may offset some of the impact. But will it be enough?
- We have to pay