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Greetings from Hong Kong, where the locals are preparing to welcome the new year on February 16. While 2018 is the Year of the Dog on the traditional Chinese calendar, on the nontraditional Mauldin calendar we call it the Year of the Octopus.

I don’t know exactly what’s coming, but I’m pretty sure it has more than four limbs. Photo: Getty Images In last week’s letter, “,” I gave you my own fairly upbeat 2018 forecast.

I think the US economy and markets will probably hold up well, thanks to tax cuts and deregulation – assuming the Federal Reserve gets no more hawkish than it already has. That assumption may be a stretch, given the Fed’s changing composition, but I’m feeling optimistic anyway. The one real potential wrench in the works that I did not mention last week was Trump’s actually enacting significant tariffs or tearing up NAFTA, which would cost millions of jobs and cause significant backlash. I am hopeful that mistake won’t be made. This week and next we’ll look at forecasts from some of my most trusted friends and colleagues. I have so many that our project may even stretch into a third week.

Some disagree with my own views – and that’s perfectly fine. I want you to see all sides so you can make good decisions for your own family and portfolio. I’ll let these forecasters speak for themselves in longer quotes than I usually allow, then add my own comments. Before we start the trek, I want to mention that we’re closing the doors to the Alpha Society soon – on January 15, to be exact. While my instinct is to always keep doors open, the Alpha Society needs to stay exclusive in order to thrive. I talked about it in a two-minute video we recorded over the holidays. Please do me a favor.

I am looking forward to meeting many of my Alpha Society and VIP members in Hong Kong this Sunday late afternoon/evening. I always find such times to be great learning experiences.

Hunt: Chaotic System Let’s start not with a forecast but with an important story about forecasts. It appeared on Ben Hunt’s always-excellent Epsilon Theory site last month, in a piece he titled “.” Keeping it in mind as I read the various annual reports and year-ahead forecasts has proved quite helpful. Thank you for subscribing Next we turn to Paul Krugman, who is not generally one of my favorite economists. I quote him this time because he sounds a lot like, well, me. So we’re living in an era of political turmoil and economic calm. My answer is that it probably can’t, because the return to normalcy is fragile. Sooner or later, something will go wrong, and we’re very poorly placed to respond when it does.

But I can’t tell you what that something will be, or when it will happen. The key point is that while the major advanced economies are currently doing more or less OK, they’re doing so thanks to very low interest rates by historical standards. That’s not a critique of central bankers. All indications are that for whatever reason — probably low population growth and weak productivity performance — our economies need those low, low rates to achieve anything like full employment.

And this in turn means that it would be a terrible, recession-creating mistake to “normalize” rates by raising them to historical levels. But given that rates are already so low when things are pretty good, it will be hard for central bankers to mount an effective response if and when something not so good happens. What if something goes wrong in China, or a second Iranian revolution disrupts oil supplies, or it turns out that tech stocks really are in a 1999ish bubble? Or what if Bitcoin actually starts to have some systemic importance before everyone realizes it’s nonsense? That was from Krugman’s January 1 New York Times column, and his assessment is not far from my own view. I wrote the previous day that the economy is pretty good and will likely remain so until something makes it change course. Like Krugman, I don’t know when that will happen, or exactly how, but I’m sure it will.

The difference between us is that Krugman has made a remarkable turnaround since the imminent doom he predicted right after the election. In fairness, he utters a little mea culpa in this column, admitting that he let his political feelings distort his economic judgment. So I’m glad to welcome his Damascene conversion. I hope it sticks this time. Rosenberg: “Pretty Late in the Game” I don’t know any economic forecaster more prolific than David Rosenberg is.

I don’t know how he even finds time to sleep, frankly. His Breakfast with Dave is often the same length as my weekly letters, and he writes it every working day. Dave’s December 29 letter was a tour de force on world markets, which I can’t possibly summarize and do any justice to the original, so I’ll cut straight to his conclusion. In other words, expect a year where volatility re-emerges as an investable theme, after spending much of 2017 so dormant that you have to go back to the mid-1960s to find the last annual period of such an eerie calm – look for some mean reversion on this file in the coming year. This actually would be a good thing in terms of opening up some buying opportunities, but taking advantage of these opportunities will require having some dry powder on hand. In terms of our highest conviction calls, given that we are coming off the 101 month anniversary of this economic cycle, the third longest ever and almost double what is normal, it is safe to say that we are pretty late in the game. The question is just how late.

We did some research looking at an array of market and macro variables and concluded that we are about 90% through, which means we are somewhere past the 7th inning stretch in baseball parlance but not yet at the bottom of the 9th. The high-conviction message here is that we have entered a phase of the cycle in which one should be very mindful of risk, bolstering the quality of the portfolio, and focusing on strong balance sheets, minimal refinancing risk and companies with high earnings visibility and predictability, and low correlations to U.S. In other words, the exact opposite of how to be positioned in the early innings of the cycle where it is perfectly appropriate to be extremely pro-cyclical. So it’s either about investing around late-cycle thematics in North America or it is about heading to other geographies that are closer to mid-cycle — and that would include Europe, segments of the Emerging Market space where the fundamentals have really improved, and also Japan. These markets are not only mid-cycle, and as such have a longer runway for growth, but also trade relatively inexpensively in a world where value is scarce.

Dave gives us some geographic focus, and it’s mostly outside the US and Canada. He likes Europe, Japan, and some emerging market countries because they are earlier in the cycle. He’s certainly right on that point, though I think we may differ on how long the cycle can persist. The past doesn’t predict the future. For the record, in my own portfolio design, we are about 50% non-US equities.

My managers are finding lots of opportunities outside of the US. Thank you for subscribing Wien: “Speculation Reaches an Extreme” We’ll wrap up today with an annual tradition: Byron Wien’s annual “Ten Surprises” list. It always causes me a little cognitive dissonance because by definition you can’t “expect” a surprise. That aside, Byron’s list is always a useful thought exercise. China finally decides that a nuclear capability in the hands of an unpredictable leader on its border is not tolerable even though North Korea is a communist buffer between itself and democratic South Korea. China cuts off all fuel and food shipments to North Korea, which agrees to suspend its nuclear development program but not give up its current weapons arsenal.

Populism, tribalism and anarchy spread around the world. In the United Kingdom Jeremy Corbyn becomes the next Prime Minister. In spite of repressive action by the Spanish government, Catalonia remains turbulent.

Despite the adverse economic consequences of the Brexit vote, the unintended positive consequence is that it brings continental Europe closer together with more economic cooperation and faster growth. The dollar finally comes to life. Real growth exceeds 3% in the United States, which, coupled with the implementation of some components of the Trump pro-business agenda, renews investor interest in owning dollar-denominated assets, and the euro drops to 1.10 and the yen to 120 against the dollar. Repatriation of foreign profits held abroad by U.S. Companies helps. Economy has a better year than 2017, but speculation reaches an extreme and ultimately the S&P 500 has a 10% correction.

The index drops toward 2300, partly because of higher interest rates, but ends the year above 3000 since earnings continue to expand and economic growth heads toward 4%. The price of West Texas Intermediate Crude moves above $80. The price rises because of continued world growth and unexpected demand from developing markets, together with disappointing hydraulic fracking production, diminished inventories, OPEC discipline and only modest production increases from Russia, Nigeria, Venezuela, Iraq and Iran. Inflation becomes an issue of concern. Continued world GDP growth puts pressure on commodity prices. Tight labor markets in the industrialized countries create wage increases.

In the United States, average hourly earnings gains approach 4% and the Consumer Price Index pushes above 3%. With higher inflation, interest rates begin to rise. The Federal Reserve increases short-term rates four times in 2018 and the 10-year U.S. Treasury yield moves toward 4%, but the Fed shrinks its balance sheet only modestly because of the potential impact on the financial markets.

High yield spreads widen, causing concern in the equity market. Both NAFTA and the Iran agreement endure in spite of Trump railing against them. Too many American jobs would be lost if NAFTA ended, and our allies universally support continuing the Iran agreement. Trump begins to think that not signing on to the Trans-Pacific Partnership was a mistake as he sees the rise of China’s influence around the world. He presses for more bilateral trade deals in Asia. The Republicans lose control of both the Senate and the House of Representatives in the November election. Voters feel disappointed that many promises made during Trump’s presidential campaign were not implemented in legislation and there is a growing negative reaction to his endless Tweets.

The mid-term election turns out to be a referendum on the Trump Presidency. Xi Jinping, having broadened his authority at the 19th Party Congress in October, focuses on China’s credit problems and decides to limit business borrowing even if it means slowing the economy down and creating fewer jobs.

Real GDP growth drops to 5.5%, with only minor implications for world growth. Xi proclaims this move will ensure the sustainability of China’s growth over the long term.

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Whatever your predisposition, there’s plenty to both like and dislike in there. On #7, I think 10-year Treasury bonds at 4% or more will look like the end of the world to younger folks. It’s been more than a decade since we saw any such thing, and at that point they were falling, not rising. But if he’s correct that CPI pushes over 3%, then bond yields have to rise. Personally, I think I would take the other side of that bet. I think the yield on the 10-year actually has a chance to fall. On another note: If Byron is right that “speculation reaches an extreme,” the resulting correction will be a lot deeper than 10%.

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I don’t think we are there yet and probably won’t reach that point in 2018. But we will get there eventually. All right, my stack of New Year’s predictions is barely any smaller, but we’ll stop here and pick up again next week. Jet-Lagged in Hong Kong, Sarasota, and Boston Shane and I are in Hong Kong, and the first 24 jet-lagged hours have been difficult, to put it mildly. But one soldiers on, and I did get my new shirts. This is the third time in six years I have visited the same tailor, and he was really surprised about the change in my neck size.

It’s a full inch larger than it was two years ago. Now I again have shirts that I can button and wear a tie with. Mount.machining@gmail.com Jan. I have to nitpick on the physics.

A system with “no closed-form solution” is not necessarily unpredictable (it is usually very predictable). The three body problem (or n-body problem) is solvable. It just isn’t solvable with a closed-form set of equations. Many problems is physics are like that. The statement “This is a chaotic system, meaning that the historical pattern of object positions has ZERO predictive power in figuring out where these objects will be in the future.

There is no algorithm that a human can possibly discover to solve this problem. It does not exist.” is completely false. There are definitely algorithms to solve the problem, but the algorithms are iterative because they are based on differential equations. Many numerical techniques exist to solve problems that don’t have closed-form solutions. © 2018 Mauldin Economics. All Rights Reserved. Thoughts from the Frontline is a free weekly economic e-letter by best-selling author and renowned financial expert, John Mauldin.

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