First up, of course, please permit me to wish all my readers, whether market professionals or just interested observers, a very happy and prosperous New Year.
With the niceties now out of the way, let’s just get a few things straight. The New Year is nothing other than a rough estimation of the winter solstice in the northern Hemisphere and the beginning of a new accounting period. Apart from that, traditionally, the world has been exactly the same as the one we left behind in December with the same old people doing the same old job for roughly the same old pay. A few people will of course have been promoted which will make them as happy as it makes those who failed to get lifted to the next level frustrated in equal measure. Newton’s Third Law of Motion….and nowhere more so than in Washington where the Donald will be handed the keys to the White House on January 20.
But can we truly “leave the politics aside, let’s get on with the economics”? The answer, as we look into the year ahead, has to be a categorical “no”. Don’t get me wrong; this observation has little, though not quite nothing, to do with Trump or Brexit or the Dutch, the French and the German elections. Despite all the rhetoric, the chances of major upsets – and I mean major upsets – in any of the three European countries that go to the polls this year are pretty small. The US election and the British referendum were straight fights with a binary outcome. The Netherlands and Germany are voting on the composition of their coalitions and France, although it looks like a binary process, is really about Marine le Pen and the Front National against the rest, a fight she is highly unlikely to win. That said, had one this time last year put a £1.00 accumulator bet on Leicester City winning the Premiership, on Britain voting to leave the EU and on Trump being elected to the White House, the pay-out would have been something in the region of £4m.
Gillian Tett of the FT, herself not an economist but an anthropologist – please bear that in mind when your young declare that they don’t want to study “something practical” like medicine, law, architecture or engineering – wrote a fascinating article over the New Year in which she postulated that many, if not most, of our mathematically based models will be of little use in 2017 and that it is to be a year when experience and instinct will take over as the key drivers of the P&L. Those who followed me closely through not just 2016 but even further back will know that she reflects my way of thinking. In fact, my last column of 2016 concluded that money was made, if indeed it was made, more by luck than by judgement. Changing the big figure on the calendar has not altered that.
This morning Singapore released its GDP figures for Q4 which showed growth of 9.1%. That might only have pushed the annual figure to 1.8% and GDP in the city state can be volatile, quarter over quarter, to say the least, but if sentiment is strong, then things will continue to improve. Much has been written about US growth and although there might be questions as to how strong it actually is, the underlying trend is positive and as the fear of a return to economic contraction and recession recedes and as confidence gains strength, it will surely become self-driving.
Meanwhile, here in Europe and despite all the doom and gloom offered up by the ECB as an excuse to maintain its asset purchase programmes, the economy looks to have turned a corner. The QE programme will surely be toned down in spring although, with the parlous state of many of the banks and not only the Italian ones, monetary stimulus will not go away.
All told, the global economic outlook isn’t at all bad and that is what creates the second big unknown, the first one being the incoming Washington administration.
Modelling
Simple analysis: economy grows, rates rise. Rates rise, bonds go down. Bonds go down, money goes into equities. Equities go up. Rates rise, discount factors rise. Discount factors rise, equities go down. Ermm? That doesn’t work. That, I guess, is why Ms Tett, unbeknown to her, basically agrees with me that models no longer work. This observational process which disproves the efficacy of most ossified models can be spun further by including the oil price factor. Consensus is that the Opec production caps will, by and large, be adhered to and that, even if the odd member tries to sneak through a few hundred thousand barrels here and there, the US$50 price level is now no longer the ceiling but the floor, US shale gas or not.
And then there is Trump. The great unknown here is not what he says he will do but the fact that we don’t yet know how wide the difference is between what he says he will do and what he actually will try to do, adjusted by what Congress will actually permit him do. The adjustment time will be one of enormous uncertainty which will stretch way beyond the famous first 100 days.
And now for the hammer blow: The past 20 or 30 years have seen developments in the asset and investment management business of practices and investment strategies that are based on general predictability, on a forecasting methodology which thrives on balanced portfolio principles. These methods are fine and dandy in stable market environments – have we forgotten how catastrophically they failed in 2008 and had the central banks not generously and seemingly selflessly bailed everyone out, would have driven most investors into the abyss? – but they will surely struggle to protect capital in an age of uncertainty. There is a clear and present danger that bond markets will deliver negative total returns for one or even two years to come but if that is the case, how can an investment manager justify holding the asset class at all? Benchmarks and indices are bull market tools that are of no meaningful value in a protracted bear market.
The post-election rally in US equities might have made all the headlines but we, the professionals, know better. What was gained on the equity swings was lost on the bond roundabouts. Credit spreads might have performed in line with equity prices but if more is lost on the bond price due to rising underlying yields than the credit spread tightening can make back, then all bets are off.
2017 will, and this is my prediction, be the year when segregated thinking has to be discarded and where the holistic, 20,000-foot panoramic view of the world will become significantly more important. The money will be in getting the big asset allocation decisions right and not in micro-managing “eek-eek” underweights and overweights. The problem is that most investment houses and their money managers are locked in by carbon fibre corsets called investor risk profiles that are in the process of being overtaken by events and that in the end will prevent rather than enhance the chances of fulfilling the first principle of asset and investment management, which is capital preservation.
This will, in all likelihood, be a year unlike any of the ones we have experienced in the past couple of decades and hence one for which very few operatives have any relevant experience. Is this the year to be sending out the headhunters to bring back some of us old but experienced dinosaurs? I think not. When the tall trees have been felled to give the saplings a change, they can’t later be re-planted. The growing saplings will have to learn to weather the storm on their own.
So finally here’s the forecast. Equities higher, bonds lower, oil at US$60, long dollars for the first three months of the year and then a buyer of euros. Unless you’re UK based, steer clear of the pound. Own anything Swiss. Don’t touch Africa in 2017 and avoid Latin America for the first half of the year before reviewing seriously. Asia looks generally okay and Japan is probably a decent buy. Avoid gold. This is my fundamental long-term strategic prediction, which I will probably fundamentally change again tomorrow.
All the best to all of you for the New Year and remember, if you see a Goldman Sachs banker jump out of the window, follow him because there’s bound to money to be made on the way down…