Doug Kass’ 15 Surprises for 2016 1

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Originally published 12/29/2015

It’s that time of the year again! Time 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 (In the short term he 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 he was 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. 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.)

Doug Kass’ 15 Surprises for 2016 2

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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:

Doug Kass’ 15 Surprises for 2016 3

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“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:

1. How wrong conventional wisdom can consistently be.

2. That uncertainty will persist.

3. To expect the unexpected.

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

5. 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 reforms initiated by former New York Attorney General Eliot Spitzer.

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.

Doug Kass’ 15 Surprises for 2016 4

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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.

A Look Back at 2015

“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

Doug Kass’ 15 Surprises for 2016 5

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Originally published 12/29/2015

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

Doug Kass’ 15 Surprises for 2016 6

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• 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 near-$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 the Fed. Most notably, no one projected that oil prices would fall to under $35 a 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.

Doug Kass’ 15 Surprises for 2016 7

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• 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: $120Source: 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: 2100Source: 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!

Doug Kass’ 15 Surprises for 2016 8

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Originally published 12/29/2015

15 Surprises for 2016

“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 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 my 15 Surprises for 2016:

Doug Kass’ 15 Surprises for 2016 9

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Surprise No. 1: Terrorism Dismantles an Already Fragile Global RecoveryI 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, and entertainment companies (especially theme-park related) might suffer the most throughout the year.

Surprise No. 2: Terrorism Goes CyberMiddle 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 and 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 InfrastructureThe 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 TankToo 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.

Doug Kass’ 15 Surprises for 2016 10

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Originally published 12/29/2015

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 Recession 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 consensus of today’s 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 two 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.

Doug Kass’ 15 Surprises for 2016 11

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Surprise No. 6: StagflationI 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 RatesLow U.S. nominal GDP growth (under 3%) didn’t stop the Fed from raising rates in December 2015, 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 fall short for procedural reasons, but pressure will remain on her throughout the year and into 2017.

Surprise No. 8: China and Russia’s Economies FalterChina’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 UnravelGerman 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.

Doug Kass’ 15 Surprises for 2016 12

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Surprise No. 10: It’s Hillary vs. The DonaldThe 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 Senator 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 TankThe 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 sour 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 a 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.

Doug Kass’ 15 Surprises for 2016 13

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Surprise No. 13: Goodbye FANG and NOSH, Hello CRABBYTFANG 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), the Blackstone Strategic Credit closed-end fund (BGB), and Allegheny Corp. (Y).

Surprise No. 14: More UnicornsExpect 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, shares fall 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

Doug Kass’ 15 Surprises for 2016 14

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Originally published 12/29/2015

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.

• High-end real estate prices in New York City, the Hamptons, and Los Angeles fall 15%. National home prices drop by 5%.

• Water grows scarcer 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.

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