Byron Wein was senior investment strategist at Morgan Stanley until 2005, when he left to join Pequot Capital Management, a hedge fund in Westport, Conn. Each December, Wein forecasts 10 possible surprises for the year ahead, events that may not be on Wall Street's radar but nevertheless have good chance of occurring. His prescience on market issues has won him a wide following. In an interview with TIME contributing editor John Curran, Wein reviews his 2009 list and opines on the stock market's prospects.
TIME: The stock market is acting horribly. Is another big sell off in the cards?
Wein: I thought the market made a pretty good bottom in November, and clearly we didn't. I don't think it's over yet. We are still in a dangerous area because the good news hasn't started yet and the bad news is still coming through.
When will good news start to appear?
We will start to see some good news on the macro level by the end of the year. The stock market will anticipate that well in advance, and by mid-summer the market will be doing better. It's kind of a confusing period where the fundamentals, such as employment, are getting worse. And yet we're still far away from the positive effects of the American Recovery & Reinvestment program [i.e., the government stimulus], so the market is apprehensive about discounting those expected positive developments too early. But I do think by the summer the visibility of positive developments will improve. (Read "How to Know When the Economy Is Turning Up.")
The big forces now weighing on the market are housing and bad bank assets. Will investors need to see resolution on those fronts before bidding stocks higher?
You'll need to see three things for the stock market to improve: 1) toxic assets taken off the bank balance sheets so banks can start lending, 2) some stabilization of house prices so that people don't feel they'll be better off waiting a month before they buy. 3) unemployment stops rising so that people start feeling more secure about their jobs. I think you'll see those three things begin to take place before the end of the year.
What's the psychology in the professional investment community now? Are the pros as scared as the general public?
Everyone is maximum conservative. The amount of money in money market funds is about half the aggregate value of the S&P 500. That's an unbelievable ratio. Even in hedge funds, which are ordinarily leveraged [i.e., more than 100% invested], they are now less than 100% invested, in some cases less than 50% invested. So everyone is maximum defensive, which is basically good news because if the fundamentals turn, there's plenty of cash to get the market going. On the other hand, the news is still bad and investors have been burned. The market was down 37% last year; it's down more than 20% this year. People feel they are in a situation that is fundamentally different from anything that they have experienced in their lifetimes. The transcendental worry is that we are in a long recession, where GDP could be negative for several years, that this is not a normal cycle where the recession lasts 18 months. It's already lasted 18 months, and it looks like it's getting worse. So until you see the prospect of real GDP turning positive, people are going to be very defensive. (See pictures of the top 10 scared traders.)
What are odds of such a prolonged recession?
There's at least a one out of four chance that it occurs.
How do you feel about your list of `10 surprises for 2009," which you issued in December? You say these "surprises" have a 50% or better chance of occurring. For some, the odds look longer than that.
Okay, let's review my list:
*The first one, that the S&P 500 would go to 1,200 by the end of 2009, wasn't a crazy idea at the beginning of the year — but it sure is now (The S&P 500 is currently around 700).
*The price of gold would go to $1200 per ounce. I still feel terrific about that.
*The price of oil will go to $80 per barrel...I feel good about that.
*The US dollar would weaken later in 2009...I still believe that.
*The 10-year Treasury yield would rise to 4% (on Monday, the yield was 2.9%.) I'm still going with that.
*China will grow 7% in 2009. That growth estimate may be high, but China will definitely see 5% growth.
*State and local governments will get into trouble. That's already happening.
*Housing starts will reach bottom. I feel pretty good but not absolutely confident about that.
* The savings rate fails to rise above 3%. It has is already hit 5%, so it has moved above that
* Obama becomes more hawkish. I definitely feel good about that.
If the economy does get a stimilus lift, how will that play out in the stock market?
I don't think the United States is going to grow faster than 3% at any time in the next five years. So we're not going to have the same kind of growth we had in the '90s, which was technology driven. And the decade we are currently in was really credit driven. As for this economy, I can't see where the big thrust is going to come from, so it's going to be a very slow growth recovery, and that means earnings growth will be relatively modest. Typically, from a bear market bottom you have a 30% to 50% rise, but this time because the earnings growth will be mild, I think the market gain will also be more modest.
So this is not the time to be loading up on classical recovery plays, like small-cap stocks?
You can buy the highest quality stocks, Microsoft, General Electric, etc., at prices that you probably thought would never be possible, so there's no need to go lower on the quality scale.