Background My rule of thumb is that I have about 1 good macro-level idea per year.
I tend to think that my predictive accuracy is pretty good, but it is also possible that there is some historical revisionism happening where I remember my correct predictions and forget my incorrect predictions. In fact all research into human psychology suggests that would be the expected case.
I have sometimes been too early in my prior predictions which makes it very fortunate that I did not had enough capital to short dot coms in 1999! “The market can remain irrational longer than you can remain solvent.†(Keynes) is one of the wisest statements in investing.
The Test So the only way to test if these predictions are accurate is to write them down, preferably publicly, so here they are.
Comments, contributions and your own predictions are very welcome! I will put a permanent link on the right hand side so we can find this post and review how we do.
This post will be updated at least once a quarter, if not more often, but new entries will be time-stamped.
This is the first post, at end of Q1 2007.
This by no means should be construed as investment advice
PREDICTIONS COMPLETE SO FAR
1. Subprime underwriting bubble and drop in underwriting standards exposed as unsustainable.
STATUS: Correct. March 2007. This one is complete
2. Complex distribution of risk in subprime mortgages through financial instruments like CDOs does very little to protect against stupid credit / underwriting risks. The thought that slicing and dicing the risk makes it somehow less risky is false.
STATUS: Correct. March 2007. This one is complete
3. Stand-alone subprime mortgage originators have a 1998-style industry shake-out with tremendous drops in valuation and bankruptcies.
STATUS: Correct. March 2007. This one is complete
Now in subprime I was a bit advantaged because I have been following the space since just before the 1998 credit crunch and subsequent collapse of most subprime originators. We'll see about broader trends...
PREDICTIONS STILL OUTSTANDING
A. Mortgage
1. Subprime MBS continue to underperform through 2007 and Q2 2008. We have not seen the worst of things yet.
2. Alt-A MBS underperform from now Q2 2007 to late 2008. The concept that this is an issue contained to subprime is put to rest by the end of Q3 2007. Keep an eye on Indy Mac as a bellweather.
3. Housing prices fall by 20%+ in certain regions as the appraisal cycle starts to work in reverse. In other words, lower appraised values push more homeowners into low/no equity situations, leading to more foreclosures, lower sales prices and lower appraised values. Values start falling in 2007 through mid 2008.
4. Investment banking investments in subprime origination platforms in 2006 turn out to have been terrible investments at the peak of the market. Note this has already happened, it is just not fully disclosed yet.
B. Buyouts
1. Multiple LBO funds IPO in 2007 after Blackstone. Let's say at least 3 in total but no more than 6.
2. High-yield credit tightens from late 07 to late 08. Spreads and covenants start to return to historical norms.
3. First higher-than-expected losses to the junior (CDO) tranches of high-yield issuances in 2008.
4. More regulatory pressure by 2008, either regarding tax rates or fees earned by the senior MDs, particularly of the publicly traded vehicles.
5. At least one very visible PE-backed company blow-up from Q2 08 to Q2 09.
6. 2008-2010 are tougher years for the PE industry as a) ability to lever deteriorates, b) revenue growth at companies slows, c) public markets are less accomodating to leveraged IPOs, d) competition for deals does not ease. Holding times increase and more time is spent on operations.
7. Overall, 2006-2007 vintage funds underperform. 2009-2010 vintage funds perform well as markets and valuations correct or over-correct. I have no opinion about 2008 vintage.
2007-2008 vintage distressed debt funds do well also.
#7 is a long-range prediction so if I am off by a year, I am still claiming victory!
C. Overall:
1. Economy weakens substantially in 2008 into a growth recession or actual recession. I am less sure of this than of my other predictions but think it is more likely than not. If this happens at the wrong time relative to the coming housing/mortgage bust, it severely aggravates issues in housing and the two cycles self-reinforce.
2. Dollar crosses 1.40 against the Euro at some point in 07/08.
3. All forms of credit tighten by late 2007 to mid 2008 and yield spreads start to return to historical norms
4. New President in Q4 2008 inherits a weak and vulnerable economy.
Once again:
This by no means should be construed as investment advice