Hindsight is a powerful but deceptive phenomenon. Inherently unpredictable events are remembered as being completely obvious after the dust has settled. But what about foresight; how useful is that in making investment decisions? Understandably investors would give a great deal for tomorrow’s news. Forewarned is to be forearmed, or so they say, but prior knowledge of the political outcomes in recent years would have been almost useless to most investors.
Given the recent political uncertainty in the UK, US and Europe, it would have been easy, almost logical, to conclude that stock markets would be in turmoil but in fact they have continued to power ahead throughout 2017. Foresight of dollar strength in the early part of 2017 and negative emerging market data would have caused even the most adventurous investors to sell risk assets but emerging market equities performed strongly thereafter. A clairvoyant investor with certain knowledge that the elections in Germany late last year, and the failed coalition negotiations, would seriously weaken Chancellor Angela Merkel’s position may not have anticipated that this political uncertainty would have little impact on UK and European financial markets.
2017 has been a great illustration of why investors should look past short term political developments, but explaining the paradox of low market volatility, record highs for the world’s stock markets and reduced levels of investor anxiety despite rising political risk is difficult other than falling back on the ultimate catch all explanation; investors are now conditioned to expect a barrage of monetary easing if there is any sign of economic weakness or financial stress. Abundant liquidity is a rising tide that floats all boats, and is one of the reasons why passive investing, tracking an index where money is allocated in accordance with market capitalization rather than by value, has become so popular and successful in recent years. It feels great until the tide turns.
(It is perhaps worth noting that our research confirms that none of our Active Fund Managers held shares in the ill-fated, recent corporate casualty, Carillion PLC, but the shares would have been held firstly by a Footsie 250 index tracker and then when Carillion fell out of that index, by a Footsie All Share index tracker)
However, there is now a growing opinion that monetary stimulus is played out and the rise of populist politics in 2016 and 2017 has placed austerity in abeyance. Government debt is at record levels and some countries, notably the UK, are also running substantial budget deficits, but these deficits are now under upward rather than downward pressures. The are many reasons for this shift, starting with sheer austerity fatigue. However, the more fundamental issue is that global growth, constrained as it is by excessive debt, has been too anaemic. Monetary policy is now widely perceived to be insufficient on its own to stimulate higher demand. The experiment with negative interest rates, which was undertaken with virtually no academic study, has proved very disappointing in its effects.
The result has been calls in both the academic and financial press for fiscal, and not just monetary, policies to be used as a weapon to avoid the deflationary recession so dreaded by central bankers and governments. A key element of these calls is that fiscal stimulus can by-pass the financial system and be directed towards new investment. As a result, increased government funded infrastructure spending and reforms in taxation are beginning to take shape. This is most notable in the US with wide ranging tax reform and dramatic cuts in corporation tax.
Although it is early days, for the first time since the global financial crisis in 2008, the global economy appears to be experiencing reflationary pressures. We are beginning to see real evidence of economic growth and inflation. Throughout the world, manufactures’ order books are at high levels and Purchasing Managers Indices are well above the 50 line that separates growth from contraction. Analysts are becoming increasingly upbeat about corporate earnings not only in the US, Europe and Japan, but also in emerging markets.
Global earnings are collectively posting some of their best performances since the financial crises and this trend should be maintained if world growth gains momentum. Corporate earnings in Japan are particularly impressive with pre-tax profits rising substantially in recent quarters, the highest level in a decade.
Global reflation is also driving the fixed interest markets, particularly in the US where it is now expected that interest rates will continue along a gradual rising trend throughout 2018. Long dated bond yields have risen, and this will benefit the banking sector with net interest margins widening, thereby boosting profits.
The UK is also showing positive economic signs with unemployment recently hitting an 11-year low at 4.8 percent, well below the average from 1971 to 2016 of 7.1 percent. Further evidence of reflationary pressures is provided by UK inflation figures (as measured by the Consumer Price Index) which rose above 3 percent in the year to December 2017.
There is also good news from the European Union, which recently agreed a trade deal with Canada that will see 98 percent of tariffs between the EU and Canada removed. In Germany, the Purchasing Managers Index for manufacturing, which accounts for about a fifth of the economy, has been well above the 50 growth line for more than 30 consecutive months.
Emerging markets, who are net producers of oil and other commodities, are benefiting from rising oil and commodity prices. As a result, both Brazil and Russia should soon emerge from long running recessions. In China, one of the key risks to the economy, is a trade war with the US and there have been a few tensions between Donald Trump’s administration and the Chinese regime. However, the Chinese Authorities hold $1.1 trillion dollars of US debt, the second largest holder of US Treasuries behind Japan. The Americans are unlikely to risk their relationship with a major creditor with a damaging trade war. Instead, they are much more likely to try to expand sensible trade agreements which will benefit world trade.
As often happens with shifts in sentiment, almost everyone now appears to view the world through rose tinted spectacles, believing that central bankers and politicians have the power of hindsight and foresight in equal measure and so will be immune to making the wrong policy decisions.
In the ever-changing circle of economic life, foresight should lead us to conclude that everything is beginning to look as optimistic for the world economy as it has done for some considerable time. However, no doubt in a few months’ time, when we look back with the benefit of hindsight, we will realise that, as always, there were risks to this half glass full scenario.
These risks include Donald Trump’s protectionist policies, the still high level of debt particularly within developed economies, political risks in Europe, the possibility of a shadow banking crisis in China and not least the threat of a war on the Korean peninsula. Whether or not any of these risks come to pass and translate into a real threat to world economies only time will tell.
Both hindsight and foresight can be useful in investment management, however it pays to remember that markets and the global economy can change relatively quickly, yet investors are looking for continued returns over the long term.
At Clarion Wealth we will continue to do what we do best; true financial planning and lifetime cash flow strategies to provide comfort and confidence for our clients. We will continue to have a balanced, long term view of the world and ignore short term noise. Whilst we remain conscious of the risks facing all investors, we also have a keen eye on the opportunities, and will continue to manage our client investment portfolios with that long term, balanced view firmly in the forefront of our minds.
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