Here we go again! Between now and the middle of January you will have to try hard if you are to avoid an avalanche of predictions about the year ahead.
One of the interesting features of this annual outlook overload is the almost total absence of diversity. Pretty much everyone says pretty much the same thing. John Maynard Keynes put it well: “Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally”.
This year the conventional wisdom seems to exert an even greater hold than usual. There’s a dominant narrative about the next 12 months, which goes roughly like this:
The Federal Reserve has started to raise interest rates, and the Bank of England will follow at a respectful distance. With inflation almost wholly absent, the trajectory of rate rises will, however, be very shallow. The world’s other central banks will, by contrast, spend 2016 easing policy further. The European Central Bank was the first to proceed in this manner by extending its quantitative-easing programme. This divergence will be the dominant theme of the year. It will lead to a stronger dollar and a weaker Euro and yen.
Commodity prices will remain weak, thanks to persistent oversupply and weak demand, notably from China, which continues to slow. Emerging markets that are reliant on selling natural resources will have another challenging year while net importers of commodities, like India, will fare better.
In a world of lower-for-longer interest rates, investors will seek a decent income where they can find it. That’s supportive for high-yielding shares, riskier corporate bonds and commercial real estate. In politics, the UK will flirt with Brexit (a British withdrawal from the European Union) but ultimately play safe. Same story in the US with Donald Trump.
For what it’s worth, that is pretty much my assessment of the outlook too, but what if I and everyone else is wrong? When so much is taken as a given, it is firmly baked into prices. If one or two of these assumptions are wide of the mark, so too will some of the others be. They are interlinked strands in the same narrative.
Confirmation bias
One of the most dangerous tendencies exhibited by investors is confirmation bias. This describes our in-built desire to seek out information which agrees with our existing views and prejudices and to reject or dismiss as unimportant whatever contradicts our beliefs.
The best investors have the humility to accept that they just might be wrong and deliberately go in search of people who think differently. A couple of years ago, for example, Warren Buffett invited a well-known hedge-fund trader who was shorting Berkshire Hathaway stock to a debate at the company’s annual meeting.
So here’s an interesting game to play. Take a few of your heartfelt beliefs for the next 12 months and imagine the exact opposite happening. How plausible does this alternative scenario sound?
Let’s imagine I’m wrong on Brexit. Instead, the polls start to point decisively towards withdrawal from the EU, Britain loses its haven status and the foreign capital that’s serviced its current account deficit dries up. The pound slides, we start to import inflation and the Bank of England is forced to hike interest rates faster and further than it hoped. How are you positioned for that outcome?
Now imagine that Saudi Arabia tires of running a massive budget deficit, abandons its bid to squeeze US shale out of the market, and coerces enough of the other cash-strapped oil exporters into a synchronised production cut. Add in a modest pick-up in activity in China and the oil price is quickly back at $US 80 a barrel.
Back in Europe, let’s just imagine that Mario Draghi’s new-found enthusiasm for monetary stimulus is too little too late and he ends up pouring petrol on the flames of a recovery that strong German data suggests might already have begun. There are more than enough dissenting voices among Europe’s leadership that support for QE2 might quickly evaporate.
Apparently when Charles Darwin came across an idea that disagreed with something he strongly believed, he would write it down immediately. He knew that if he didn’t do this, his mind would reject the idea just like a body tries to reject a transplant.
So before you put those decorations back in the cupboard, make sure you give a fair hearing to half a dozen ideas that you completely disagree with.
