Essay: The following 10 surprises are not predictions. They are 10 potential surprises, the odds of which occuring are underestimated by the current "convential wisdom". If a few of these come true I will feel pretty smart. If more than 5 come true, I will proclaim myself a soothsayer.
1. The West (namely the US) and Russia will have a major standoff over the fate of Kosovo. The magnitude of the crisis will surprise the Western media. Georgia will be sucked into the crisis somehow.
2. The US and North Korea will sign a treaty officially ending the Korean War.
3. The US and Iran will have a high-profile detente.
4. The Chinese stock market will crash by more than 30% from its peak.
5. At some point in 2008, the Fed Funds rate will be at or below 3%.
6. The US current account deficit will end the year at less than 3% of GDP.
7. The US dollar will rally by more than 10% against the Euro and the Pound.
8. Russia will effectively merge with Belarus.
9. John Edwards will be the Democratic presidential nominee.
10. John McCain will be the Republican presidential nominee.
Ok, so I'll admit that posing my predictions this way is a bit of a cop out in that I don't have to hang my hat on any of them. These are my out of the box surprises that I think could happen, but do not put greater than 50/50 odds on any one individually.
My base case prediction for 2008 is as follows:
Despite the subprime-driven credit market crisis, 2008 will be a good year for the world economy. The US will avoid a recession, with economic growth driven by exports and business investment. The technology and capital goods industrials sectors will do well. Commodity prices will stay strong, so the mining and oil sectors will also remain strong. Expect continued M&A in all of these sectors, with the ultimate end game being the formation of global oligopolies. For these and other reasons, 2008 could actually end up being a good year for the equity markets, but I expect credit risk spreads to remain elevated.
Interest-rate sensitive, consumer-driven sectors will continue to suffer, with autos hit especially hard. Some time before the end of 2009, it will become obvious that Cerberus' investment in Chrysler is in serious trouble. The housing market will continue to weaken, too. No surprise there. Housing is in for a long slump. The huge run up in prices and supply/demand imbalance are bad enough. Add in declining demographics with the baby boom generation past their home-buying years, and we're looking at a long, Japan-style real estate deflation. The demographics are bad for commercial real estate, too.
The US current account and budget deficits will continue to narrow. Because economic growth driven by a narrowing current account deficit doesn't feel as good as growth driven by a widening deficit, consumer sentiment on the economy will stay low. High CPI increases will continue, but will likely start slowing markedly near the end of the year. The US dollar has likely put in an intermediate term bottom in late 2007 and should rise modestly in 2008.
The cracks in the foundation of global growth will really start to show in 2008, particularly in the form of runaway inflation in China and the Petro-states. China will be forced to clamp down, probably just after or around the time of the Olympics, starting a chain of events that will lead to a real estate and stock market crash. The problems in the Chinese economy will likely be overshadowed by Olympics hype, however. In 2009, deflation will start to spread from China to the rest of the world.
All in all I expect the current trends to continue into 2008, but for it to ultimately be a transition year. I expect 2008 to represent the peak year of the global expansion.