There are a couple of reasons why we don’t believe that forecasting short term events is a sustainable investment approach.
First, it is very difficult: how can one have a sustainable forecasting ‘edge’ over and above what is currently priced into the market on something like an election result? Second, and most important, even if you forecast outcomes correctly, markets don’t often respond as you might expect (Brexit, and the Trump victory are examples of this, even if many us now forget just how surprised we were).
The reality is that historic market developments are rarely announced in advance. What’s more, the important fundamentals – inflation data, profits delivery, or growth news – happen gradually, in increments rather than on scheduled dates.
However it is one-off ‘events’ and linear narratives that are more appealing to the human desire for simple stories. This is partly why the episode team believe episodic investment opportunities are created; investors lose sight of the true range of possible outcomes and fundamental long term drivers of returns because they become distracted by the issue of the day. When this happens, a patient and reactive stance can be fruitful.
The below timeline represents a range of possible sources of volatility in 2018. Critically, they should not be seen as events to be ‘negotiated’ but as a potential source of opportunity should they prompt excess volatility.
Sixth round of NAFTA talks (23rd-28th)
Negotiators had set a goal to finish NAFTA negotiations by the end of 2017. For anyone who is aware of Daniel Kahneman and Amos Tversky’s ‘planning fallacy’ the fact that the deadline was not met will come as no surprise, and talks have been extended into 2018. The outcomes of the negotiations could have a significant impact should they mark a move away from open economies toward more protectionist policy, and in the shorter term could also impact the Mexican elections in July.
US Tax Reforms begin to come into force
Many aspects of the US tax reforms passed in December come into action very quickly and will begin to influence individual and corporate behaviour straight away. The genuine impacts on the economy will however take far longer to assess.
Jerome Powell to be sworn in as Fed Chair (5th)
The impact of rising rates (should they occur) on asset prices in 2018 is a key focus for many market commentators at present. Powell’s appointment was somewhat of a surprise (he wasn’t even listed among the candidates in this article in September) but his is not seen as a significant break with the status quo. Ultimately it seems likely that the nature of the economic environment will be more important than the disposition of the Chair that happens to hold office.
Italian General Election (4th)
The Italian referendum on constitutional reform now seems like a distant memory and the relatively benign market responses to European political developments in 2017 may suggest that investors are more comfortable with these issues than they have been for some time. However, while markets have been calm, there are still signs that popular discontent with the European Union is a meaningful force; success or otherwise of the Five Star Movement could be interpreted as a barometer of sentiment.
Russian Presidential Election (18th, first round)
A victory for incumbent Vladimir Putin seems unlikely to move markets…
US Debt Ceiling
The almost traditional end of year debt ceiling wrangle in the US had little notable impact on markets in 2017. However, the ‘extraordinary measures’ introduced in December are expected to run out in March or April, and the new tax reforms could well put focus attention on the US fiscal position once again.
Chinese Report on the Work of Government
The decisions made at China’s annual Central Economic Work Conference in December are generally made public in March of the following year. The report normally provides an assessment of how the Communist party view the current state of the economy, developments in the last year, and critically, a sense of policy objectives for the future.
Haruhiko Kuroda’s term as Bank of Japan Governor to expire (8th)
We have previously discussed the profound nature of policy experimentation that has been undertaken in Japan over many years. Kuroda is expected to be reappointed, but there could be some volatility were this not to be the case.
Colombian Presidential Election (27th, first round)
Incumbent Juan Manuel Santos is unable to stand after two consecutive terms. There are a number of candidates, and a wide range of possible outcomes. Volatility could emerge should investors become concerned about the implications for the domestic peace agreement and ongoing fiscal reforms.
OPEC 7th International Seminar (20th-21st)
In November OPEC agreed to extend output cuts until the end of 2018. The International Seminar in the middle of 2018 would represent a chance to review that decision against the subsequent economic developments. There is significant debate about how much OPEC is able to influence the oil price today, but as we have previously noted, steep demand and supply curves for commodities mean that small changes can prompt material volatility.
Such volatility can always be exacerbated by behavioural influences, and growing tension in Iran and the Parliamentary elections in Iraq (12th May) could play a role in driving these forces.
Mexican Presidential Election (1st)
A victory for Andres Obrador in Mexico could mean some material changes to policy. Obrador has come close to victory before and is perceived by many as unfriendly for markets and trade.
Brexit deal to be finalised prior to ratification by the European Parliament
The EU aims to achieve a finalisation of Brexit terms within 18 months of Article 50 being triggered, allowing for ratification by the European and national Parliaments before the 29 March 2019 deadline. See ‘planning fallacy’ above, Steven’s post last year, and Christophe’s blog from 2016.
Brazil Presidential Election (7th–28th)
Volatility around Brazilian politics created investment opportunities last year. As in other South American countries in 2018, it is the implications for structural reform which are often put forward as reasons to be fearful around elections.
Thai General Election
Thailand has been led by a military junta since 2014, with proposed elections repeatedly delayed since then. The military government has announced that new elections will be held in November though a final date is to be set in June.
So, what does this mean for investors?
Unsurprisingly, the timeline above (the range of events that we can know ahead of time) are dominated by elections and policy decisions. Ultimately however, the key fundamentals that really matter cannot be diarised.
Year ahead outlooks often tell us more about what we are worried about today than what will drive asset prices in the future. While the events above could impact both fundamentals and market volatility in the coming months, investors should expect the real forces that drive asset prices in 2018 to be found elsewhere, and in many cases from sources that few if any are talking about right now.