The November surprise happened! While the world has gotten used to it in the meantime, less than two months ago the prospect of a Trump presidency looked remote. This development was unexpected to most, both to political experts and to simple citizens, in America and abroad. The measure of the surprise is even clearer considering that the candidate himself revealed after the election that he had reserved a small ballroom for election night because he expected to lose and to make only a short concession speech in front of a small audience.
No less staggering than Donald Trump’s election was the market’s reaction to it. The conventional wisdom was that such scenario would represent a source of market uncertainty and therefore hurt markets. One of the most successful investors who made many billions helped by his understanding of the economy and the markets anticipated a fall of up to 10% in equity prices in case of a Trump win. Instead, markets jumped up 5% on the day following the election and have since rallied to new all-time highs.
At the beginning of a New Year many expect managers look into their crystal balls to generate market predictions for the next twelve months. Some oblige and often these predictions are formulated in extremely precise terms which reinforces the “scientific” appearance of these forecasts. The risk to the forecasters is limited. If the predictions do not materialize people usually forget that they were ever made. When some of them happen to materialize the author will all too happily remind the audience that “I told you so”.
The two major yet largely unexpected developments mentioned earlier illustrate well the limits of forecasts. We are not aware of any manager or expert who at the beginning of 2016 expected both Donald Trump to win and the markets to rally to all-time highs. There was general market scepticism at the time dominated by the concerns regarding the Chinese economy.
Therefore, we do not publish detailed forecasts at the beginning of a new year. We are not aware of any investors or financial institution, even among the most successful, which over the decades has been able to reliably call even the general market direction twelve months out let alone to set-up correct targets. Conventional wisdom is often wrong. One of the most famous examples is the cover story of BusinessWeek in August 1979 entitled the “Death of Equities”. Just as the market was about to embark on the strongest bull markets in history (up 20 times) they wrote:
“Further, this “death of equity” can no longer be seen as something a stock market rally—however strong—will check. It has persisted for more than 10 years through market rallies, business cycles, recession, recoveries, and booms.“
This was not simply an individual opinion but the reflection of the views of the leading bankers and experts of the time.
This high level of uncertainty and unpredictability is the major challenge faced by all investors. As we like to emphasize, we believe that our role is to position portfolios in such a way that they will be able to successfully weather any headwinds and get safely across to the next year. This requires effective but not excessive diversification and to identify individual investments which can be expected to do well in a variety of environments. Such approach will ensure a limited level of volatility and downside. It will by its nature usually increase less than the market in good years but should also prove more resilient in times of crisis. Over the long-run it should therefore deliver attractive returns as major drops in asset prices are long-term performance killers. It is important to remember the asymmetry between losses and gains: one needs an 11% gain to offset a 10% loss but a 50% loss requires a 100% gain to be offset!
While we do not make forecasts a careful analysis of the market risks and opportunities is at the center of our reflections and there are instances where we consider the evidence to be sufficiently solid to justify a directional view.
With the election of Donald Trump and the expectation of an expansionary fiscal policy the market now anticipates an increase in interest rates. We basically share this analysis and believe that the thirty years bull-run in bonds is over. As a consequence we would continue to stay away from fixed-coupons bonds or bond proxies such as “low-volatility equities” with long durations. Inflation protection should also regain more prominence in investment considerations.
We also believe that the current situation should be supportive of the dollar. As interest rates are still at zero or below in many key markets outside the US the difference in interest rates and the relatively good economic performance will draw capital to the US. However, the appreciation potential is limited by the fact that the dollar has already enjoyed a strong and protracted cycle, is trading high relatively to other currencies and will eventually become a drag on American exports.
In terms of equity markets the picture continues to be nuanced in our view. Consensus is bullish based on a relatively solid economic situation, the upcoming fiscal stimulus, deregulation measures and tax cuts of the Trump administration. There remain however significant risks. Increases in interest rates have often been negative for equity markets. Valuations are not extreme but demanding. If implemented, Donald Trump’s policies will significantly increase the risk of overheating and inflation in the middle term which the market seems to overlook in its current state of euphoria. Considering these significant risks an exogenous factor such as a war or an international crisis can be the catalyst of a significant correction which usually happens when people least expect it.
We look forward to the adventure of 2017. We thank you for your confidence and will continue to deploy all our efforts to get safely to 2018.
Orit Raviv Swery - Founder & CEO, Ilan Weil - Chief Investment Officer