Blackstone Quarterly Webcast: The Ten Surprises of 2022

Almost from the beginning of last year, we began thinking about the Surprises of 2022. By that time, effective vaccines had been developed and people had begun getting them, but we were still uncertain about when we might return to something like the life we knew in 2019. We kept pondering the secular changes. Working remotely was one major change, and it seemed to have proven effective, to a degree, for many office employees. We all missed the interaction with our colleagues—the camaraderie, the mentoring—but many of us found we could get important parts of our jobs done without commuting every day. We wondered when schools would begin functioning with in-person classroom instruction, and whether colleges would consider lowering tuition as they explored the potential and cost savings of hybrid learning. Cultural institutions—such as theaters, concerts, and museums—are such an important component of urban life, and we spent time considering when they might return to their normal schedules and programs. We did the same for travel, the bulk of which was suspended during 2020. There was a feeling that life would not be quite the same post-pandemic, but what shape our “new normal” would take was not clear. 

In looking back at our list of the Ten Surprises of 2021, it turns out that we had a pretty good sense of how the recovery would unfold and what the important economic and market implications would be. Our definition of a Surprise is an event that we believe is probable, with a better than 50% chance of taking place, but that the average investor would assign only around a 33% probability. While we speculate on the events of the year to stretch our own thinking and that of our clients, we don’t intend to get a high score. Even so, seeing that some of our non-consensus views were on target is gratifying.

For our first Surprise, we thought that we had not heard the last of former President Donald Trump. We did not anticipate the events of January 6th; rather, we expected him to stay in the public consciousness by starting his own television network. He would personally star in its lead show The Chief—an interview program in which the former president would discuss issues of importance with heads of state, business leaders, and celebrities. Despite getting the details of this Surprise wrong, we got the overall thrust right. Rather than a television network, Trump announced the launch of his own social media platform, after being famously banned from Twitter and Facebook. And while the former president spends less time in the limelight these days, he has retained his political potency. He maintains a prominent position in the Republican party with a broad constituency and remains the frontrunner for the 2024 Republican primary should he choose to run.

In Surprise Two we expected President Joe Biden to establish a more constructive relationship with China’s President Xi Jinping. We thought, as we do today, that conflict between the world’s two largest economies was not good for trade or geopolitics. We would say that we got this one wrong. While US Secretary of State Antony Blinken met with Chinese officials in Anchorage last spring, the talks did not go well. China clearly wants to bring Taiwan within its fold and to become the dominant military, political, technological, and economic leader of the world by the 100th anniversary of the founding of the People’s Republic of China in 2049. It thinks its authoritarian system and ideology will take it there, and it believes that America is weak and in decline. Because of the uncertainty related to the outlook for publicly traded companies in China, investors generally remain apprehensive, and the Shanghai Composite Index has significantly underperformed this year. 

In the third Surprise, we expected that a number of vaccines would bring COVID-19 under control. We thought people would have to show proof of vaccination at airports and public places—a relatively novel concept just a year ago—but that life would gradually approach normality by Memorial Day. That turned out to be too optimistic, but several weeks before that holiday, the Centers for Disease Control and Prevention (CDC) lifted the indoor mask guidelines for fully vaccinated people, which many people saw as the first step towards something that felt more like “normal.” More people are going into the office on a regular basis, cultural institutions are operating, Broadway is limping back and people are eating indoors in restaurants again. While we have not yet returned to normal, we have made terrific progress towards reopening the economy compared to where we were last autumn. 

For Surprise Four we said that government agencies would begin to take a more benign view toward the leading technology companies and reverse their efforts to break them up. We thought they would be unable to determine that consumers are hurt by the power of these firms. This is another one we got wrong. While the intensity of the effort to break up Big Tech may have diminished somewhat, the feeling remains that the companies have too much influence over our lives, affecting politics, child development and daily life. Whether the Justice Department will decide that breaking companies up or regulating them more strongly is the right course of action is arguable, but that policymakers in Europe and the United States clearly believe something should be done. Recent high-profile Senate hearings involving Big Tech executives have emphasized their resolve.  

In the fifth Surprise, we anticipated business would develop momentum on its own because of pent-up demand. We even expected airline and hospitality stocks to recover, although maybe not fully back to 2019 levels. We thought that real GDP growth would be 6% and unemployment would drop to 5%. It turns out we didn’t go far enough in our already above-consensus views. Growth has been even stronger than we expected, and the latest unemployment rate was reported at 4.2%. More importantly, we thought the recession of 2020 was a serious one, and that the recovery would become self-sustaining and last for multiple years. This seems to be the case, as the US economy has benefited from unprecedented fiscal and monetary stimulus. Federal Reserve tapering has just begun, and we may expect to see interest rate increases imposed in 2022 to deal with inflation. This argues that we probably have several more years before a recession becomes a serious danger.
 
We were also right in expecting that Modern Monetary Theory would become integrated into the thinking of policymakers in the government, which was the sixth Surprise. The Federal Reserve balance sheet has expanded to $9 trillion, more than doubling in the last few years, and the national debt has increased from $6 trillion in 2000 to well over $20 trillion. Whether they admit it or not, our policymakers are operating on the assumption that we can run large budget deficits and expand our Fed balance sheet as long as people will buy our bonds. Perhaps more significantly, market participants seem to believe in MMT too, because few prominent investors have expressed serious concern that the massive debt and deficits will inflict permanent damage on the US economy or the ability of the US government to service its debt. People had become complacent about the dangers of inflation because it has been tame for many years, but now that inflation is rising, we may have to rethink our easy money policies.

We really stuck our necks out on the seventh Surprise, thinking that the price of West Texas Intermediate oil would rise to $65 a barrel. Oil was trading below $50 at the time and very few people held the bullish view that it would rally significantly during the year. We thought that demand for fossil fuels would increase as the economy recovered, even though we expected the green energy movement to forge ahead. We did not count on OPEC reducing production to push the price higher. The rig count increased and oil stocks and bonds rallied as we anticipated they would, making the energy sector the market leader for the year.

Our price target for the S&P 500 was the eighth Surprise, and we set a level of 4500. That represented a 20% increase over the close of 2020. Our thinking was that the economy would recover, earnings would come in better than expected, people would return to offices, productivity would improve and sentiment would shift from uncertain to positive. At 4500, the market would be fully priced based on our earnings estimate of $225 per share for the S&P 500 index. The market traded above that level briefly.  In the current environment we believed that 20 times earnings was approximately fair value, and that the “risk-on” sentiment might become too extreme. For that reason, we thought a significant correction would occur. While there have been periods of volatility, there was no major market correction, as interest rates remained lower than we anticipated and monetary stimulus continued, which leads to the next Surprise.

We were interest rate bears all year. In the ninth Surprise we expected the yield on the 10-year US Treasury to rise to 2% as the economy recovered. We were feeling pretty good about this one as the first quarter of 2021 unfolded. The 10-year yield rocketed in the first three months of the year, nearly doubling from 0.9% at the end of 2020 to over 1.7% by the end of the first quarter. Interest rates remained below that level for the rest of the year, however, even as inflation rose above 5%. There was just too much public and private money looking for a place to hide. The United States was probably the best credit in the world and its bonds yielded substantially more than the equivalent bonds in Europe and Japan. As a result, the US attracted capital from those places, and the 10-year US Treasury did not rise to 2%. 

In the tenth Surprise, we observed that one of the most crowded trades at year-end 2020 was to be short the US dollar. We believed that the recovery in the US would impress investors, and that they would want to deploy capital in the American market, strengthening the greenback. While the currency did not do quite as well as we had expected, it did rise by mid-single digits during the year, proving the short sellers wrong.

Every year we always have a few Surprises that don’t make the basic list, because either we don’t think they are as good as the Ten we picked, or we don’t think they are “probable”—having a better than 50% chance of taking place. Last year we had three of them. In the first of these, we were worried that the economic impact of cyber attacks would become a more serious problem during 2021, with nefarious groups of computer experts around the world invading the data networks of corporations and institutions. That clearly is taking place at a considerable cost (over $1 billion in losses this year alone, according to one report) to legitimate organizations. We also thought that Tesla might acquire a conventional auto company, but Elon Musk has good reason to believe he is doing everything right and has nothing to gain from such an acquisition. Finally, we were surprised that Kim Jong-Un was not a major factor on the geopolitical scene last year.

Every year we always get a lot of help from friends, colleagues at Blackstone, and experts whose views we solicit. My Third Thursday group of former research directors is always stimulating and irreverent.  But in the end, we alone take responsibility for the Surprises. We hope that reflecting on them will be helpful to you. 

The definition of a Surprise is an event which a professional investor would assign a one out of three probability of happening, but which we think is probable, meaning it has a better than 50% of taking place.

1. The combination of strong earnings clashes with rising interest rates, resulting in the S&P 500 making no progress in 2022. Value outperforms growth. High volatility continues and there is a correction that approaches, but does not exceed, 20%. 

2. While the prices of some commodities decline, wages and rents continue to rise and the Consumer Price Index and other widely followed measures of inflation increase by 4.5% for the year. Declines in prices of transportation and energy encourage the die-hard proponents of the view that inflation is “transitory,” but persistent inflation becomes the dominant theme. 

3. The bond market begins to respond to rising inflation and tapering by the Federal Reserve, and the yield on the 10-year Treasury rises to 2.75%. The Fed completes its tapering and raises rates four times in 2022. 

4. In spite of the Omicron variant, group meetings and convention gatherings return to pre-pandemic levels by the end of the year. While Covid remains a problem throughout both the developed and the less-developed world, normal conditions are largely restored in the US. People spend three to four days a week in offices and return to theaters, concerts, and sports arenas en masse. 

5. Chinese policymakers respond to recent turmoil in the country’s property markets by curbing speculative investment in housing. As a result, there is more capital from Chinese households that needs to be invested. A major asset management industry begins to flourish in China, creating opportunities for Western companies. 

6. The price of gold rallies by 20% to a new record high. Despite strong growth in the US, investors seek the perceived safety and inflation hedge of gold amidst rising prices and volatility. Gold reclaims its title as a haven for newly minted billionaires, even as cryptocurrencies continue to gain market share. 

7. While the major oil-producing countries conclude that high oil prices are speeding up the implementation of alternative energy programs and allowing US shale producers to become profitable again, these countries can’t increase production enough to meet demand. The price of West Texas crude confounds forward curves and analyst forecasts when it rises above $100 per barrel.

8. Suddenly, the nuclear alternative for power generation enters the arena. Enough safety measures have been developed to reduce fears about its dangers, and the viability of nuclear power is widely acknowledged. A major nuclear site is approved for development in the Midwest of the United States. Fusion technology emerges as a possible future source of energy. 

9. ESG evolves beyond corporate policy statements. Government agencies develop and enforce new regulatory standards that require public companies in the US to publish information documenting progress on various metrics deemed critical in the new era. Federal Reserve governors spearhead implementation of stress tests to assess financial institutions’ vulnerability to climate change scenarios.

10. In a setback to its green energy program, the United States finds it cannot buy enough lithium batteries to power the electric vehicles planned for production. China controls the lithium market, as well as the markets for the cobalt and nickel used in making the transmission rods, and it opts to reserve most of the supply of these commodities for domestic use.