Twelve surprises for 2017
I read virtually everything Howard Marks writes. In fact, if I see one of his articles, memos or interviews I stop virtually everything I’m doing and dive straight in. I’m starting this year’s “surprise forecasts” article with a series of quotes that can be found in his latest memo titled: “Expert Opinion.” I highly recommend reading the entire memo: https://www.oaktreecapital.com/insights/howard-marks-memos
To quote some passages:
“Interest in ‘macro’ has amped up meaningfully over the last dozen years or so. I think it largely started with the increased activism on the part of the Greenspan Fed, and investors’ heightened interest in it. Today many analysts seem preoccupied with central bank behaviour, government actions, trends in interest rates and currencies, and the movement of markets, as opposed to the fortunes of individual companies.
“These things are almost all we hear about. And most people think knowledge regarding the outlook for them holds the key to investment success ….
“• There are no facts about the future, just opinions. Anyone who asserts with conviction what he thinks will happen in the macro future is overstating his foresight, whether out of ignorance, hubris or dishonesty.
“• Developments in economies, interest rates, currencies and markets aren’t the result of scientific processes. The involvement in them of people — with their emotions, foibles and biases — renders them highly unpredictable. As physicist Richard Feynman put it, ‘Imagine how much harder physics would be if electrons had feelings!’
“• It’s one thing to have opinions on these subjects, but something very different to be confident they’re right (and act on them).
“• Taking bold action based on forecasts of things that are uncertain isn’t just misguided; it’s dangerous. As Mark Twain said, ‘It ain’t what you don’t know that gets you into trouble. It’s what you know for certain that just ain’t true.”’“• Everyone at Oaktree has opinions on the macro. And when we see extremes in markets and, especially, capital market behaviour, we’re apt to take strong action. But we’re highly aware of what we don’t know, and when conditions are moderate or indistinct, we don’t bet heavily….
“… I had dinner with Warren Buffett about a year ago, and he pointed out that for a piece of information to be worth pursuing, it should be important, and it should be knowable. These days, investors are clamouring more than ever for insights regarding the macro future, because it’s important: it moves markets. But there’s a hitch: Warren and I both consider these things largely unknowable. He rarely bases his investment actions on them, and neither does Oaktree.”
I’ve said this in all my prior surprise columns and I’ll say it again; static forecasting is junk. Situations in financial markets are fluid, thus all prognostications are almost instantly stale. Trying to guess what the market will do next is like trying to nail Jell-O to a tree. No one can truly claim with certainty that they know what tomorrow will bring and if you meet someone who does you should put your hands in your pockets to check for your wallet and slowly back away. Voltaire sums it up best: “Doubt is not a pleasant condition, but certainty is absurd.” Besides, successful investing involves following the right principles and prescriptions NOT the right predictions.
So why even bother doing them. Good question. Here are some reasons. I have written these in the spirit of nudging the reader to look “outside-the-box” and consider a disparate view of things that may cause some cognitive dissonance. To second guess some “hard-held” beliefs and maybe consider alternate outcomes rather then be wedded to some concrete ideals that have been perpetrated by the consensus view. The other reason, and maybe the truest, is for readers’ entertainment.
To be clear, what follows is NOT an investment strategy or outright forecast but a list of potential surprises for 2017. Ideas that are not consensus based with explanations on why they have a good chance of happening. If you see value in these it will be the explanations that count not the actual prediction.
As a preamble let’s consider one of the major forecasting memes perpetrating the investment community right now. A lot of people are now comparing the policies of Trump to those of Reagan. Trump and Reagan prescribed fiscal stimulus, tax reform and tougher international diplomacy. “Reaganomics” led to a surge in the dollar, rising deficits and a ripping stock market. But, for some reason, very few are pointing out the current macro differences. When Reagan started as president, debt to GDP was only around 35 per cent. The economy had just suffered from two back-to-back recessions. The price-earnings ratio of the S&P 500 was in the single digits and bond yields were more than 10 per cent.
Trump starts five years into an expansion, with debt to GDP of more than 100 per cent, price-earnings ratios of the stock market at nearly 18x and bond yields near 30-year lows. The macro backdrop is almost the polar opposite. Thus, the surprise may be that the outcome is NOT just like the Reagan years.
1. Bermuda Insurance/Reinsurance M&A Continues. Think consolidation in Bermuda is finally over? Think again. Surprisingly we have another year of consolidation in Bermuda’s largest market for the following reasons: a) limited organic growth opportunities, 2) essentially zero pricing-power partially due to the large amount of excess capital in the market, c) Japanese buyers with very cheap sources of capital and a desire for US currency assets, and d) the incessant march of fintech disruption. Look for three or more mergers or acquisitions in the space.
2. Bermuda’s Economy Accelerates. The America’s Cup, hotel construction and a tourism boom (best air arrivals in more than ten years) helps propel the economy. We see job growth for the first time in more than seven years. GDP comes in at 3 per cent or better. The surprise is not that the economy has a good year, it has a great year — the best in over ten years.
3. Gold Glitters. After a five-year bear market gold resurfaces. Escalations in geopolitical risks associated with brewing trade wars, and Trump’s aggressive foreign policy sends investors looking for hedges. China’s increasing capital controls also lead the Chinese to seek other alternatives outside the yuan. Gold rallies at some point to $1,400 per ounce.
4. Trump Triumph Trade Withers. Profits are expected to rebound in 2017 and should be helped by any tax cuts enacted. Headwinds, however, persist to limit price gains in the S&P 500. The bump in the dollar crimps multinational profits once international revenues are translated back into dollars. Valuations multiples mean-revert as they are stretched and approaching levels seen in prior market peaks. Wage increases crimp profit margins along with rising credit spreads which increase the cost of debt. Trumps aggressive foreign policy stances curtails global trade. The S&P 500 ends the year in negative territory.
5. FANGs Fly. Facebook, Amazon, Netflix, and Google (Alphabet) rally. The market begins to increasingly realise that it is winner-takes-all for certain sectors of the market and that these tech companies have established increasingly large moats that are almost unassailable with their entrenched economies of scale and networking dominance. Surprising double-digit returns ensue even with a weaker market.
6. Active Management Wins. Surprisingly, after years of underperformance and the constant drum beat that active management is dead, the average hedge fund outperforms the market. Shrinking correlations among stocks, limited central bank intervention and more volatility play into more discerning strategies.
7. Biotechs Boom. Despite Trumps tweeting bombs against high drug prices, biotech companies post market-beating returns for the year. Immunology advancements and Crispr research lead do some exciting advancements in the fight against cancer. The 21st Century Cures Act helps to accelerate research and speed up cutting-edge drug approvals.
8. Europe Holds Hands. Despite four of the eurozone’s five largest economies having risky, uncertain and potentially populist elections, none of them result in a negative euro party winning. The surprise is simply that there is no surprise populist victory. The risk of the euro disintegrating is reduced markedly which helps the euro become the best developed-market currency versus the dollar in 2017. European equities outperform US equities.
9. Trump Reflation Trade Stalls. Expectations on Trump’s fiscal policies are extremely high. The market anticipates great things in a very compressed time. They are disappointed as some policies are diluted somewhat (especially the level of infrastructure projects). The whole political process delays the actual effect and the benefits won’t really be felt till 2018. The offshore tax repatriation proceeds get funnelled towards debt repayment, share buy-backs and dividends — essentially adding a diminutive amount to investment within the US and offering a “trickle-up” for wealthy shareholders. US GDP for 2017 misses the goal of “3 per cent +” for 2017 and in fact comes in less than 2.5 per cent.
10. Cobalt Surges. Commodities in general go through the year little changed. Oil remains locked in a range of $55 to $60 for most of the year on support from Opec cuts offset somewhat by the resurgence of shale production in the US Copper surges initially on infrastructure stimulus hopes but eventually trades lower on the realisation that projects are a 2018 item and of much reduced Chinese infrastructure spending. The surprise is cobalt on rising lithium battery production along with the increasing production of jet engines. This causes cobalt demand to surge to unprecedented levels. Cobalt spot prices surge in price.
11. Snapchat IPO Disappoints. A series of bigger name tech IPOs hits the market in 2017. These include Spotify, Pinterest, and Snapchat. Excessive private valuations lead most to be failed IPOs.
12. Bond Yields Remain Little Changed. On the back of a strengthened dollar rising inflation expectations begin to fizzle out. The Fed only raises twice instead of the initially signalled three times. The prior surge begins to slow interest rate sensitive industries and the market comes to realise increasing borrowing costs still adversely affect a highly levered world economy. Trump’s volatile and disjointed Tweets keep market participants interested in safe havens. The US ten-year Treasury security ends the year near where it began.
Full disclosure: Facebook, Alphabet, Sprott Physical Gold Trust and Sprott Gold Miners ETF are owned by the author and clients of Anchor Investment Management Ltd at time of writing.
Nathan Kowalski CPA, CA, CFA, CIM is the Chief Financial Officer of Anchor Investment Management Ltd. and the views expressed are his own. Disclaimer: This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by the author to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. Readers should consult their financial advisers prior to any investment decision. Index performance is shown for illustrative purposes only. You cannot invest directly in an index.
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