While you can call the year 2016 many things but you cannot say it was boring! The year started with one of the worst selloffs in history and ended with a nice rally into year-end after the US election. And of course around mid-year, the UK voted to leave the European Union just to provide some more uncertainty. The age old Wall Street expression, “so goes January, so goes the year” didn’t prove very helpful last year and in fact was about as insightful or accurate as almost every political poll taken leading up to Brexit and the US elections. Pollsters actually made economists look smart last year and that is no easy accomplishment!
Over the years, I have talked repeatedly about the dangers of “consensus” thinking and 2016 once again highlighted the risk of finding oneself safely among the herd as almost every consensus view last year was toppled. The UK would never vote to leave the European Union and heaven forbid, if it did, the markets would crater. So much for that doomsday call. Hillary Clinton was leading in the polls heading into the Presidential election with odds of her winning the White House pegged at around 80%. And if by chance Trump found a way to the White House, markets would crater with uncertainty. Well, instead, markets ripped higher on the back of Trump’s victory. Although in fairness, the rally probably had as much to do with the Senate and Congress both going Republican providing a “united” Washington that will be finally able to implement fiscal policy. It remains to be seen how “united” Washington will be with Trump in the White House.
Even if one had a crystal ball that could accurately forecast the major political events of 2016, turning that information into profits would have been a challenge. Even the astute investor George Soros reportedly lost over $1 billion betting against the market after the Trump victory. Predicting events and how the markets will interpret those events is exceedingly hard in this interconnected world. The larger the consensus, the more likely it is that money will be lost joining the crowd at the later stages. Trend following is great if you can spot the trends early in their formation and get out before the maximum consensus is formed. Easier said than done of course, but I instinctively (and perhaps to a fault) push against trends and consensus views.
Since the election, markets have reacted to President Trump’s stated agenda which is ambitious to say the least but short on actual details. He has promised huge tax cuts and massive infrastructure spending. Trump has promised to tear up Obamacare in favor of a better model with no details as of yet. Remember, President Obama spent almost all of his first term’s political capital getting the Affordable Care Act passed and somehow a better model will be unveiled that will solve all of its shortcomings.
Trump wants to renegotiate almost every major trade deal with better terms for American companies. Sounds good, yes please! Lastly, Trump wants to unwind many of the regulations that have been heaped onto business since the Financial Crisis, particularly in the financial services sector. The whole world is tired of government red tape and regulations and this theme was also expressed in the Brexit vote as the British were weary of Brussels and the endless regulations.
So while markets have enjoyed the honeymoon, celebrating all of these good things that have been promised leading up to the inauguration on January 20th, the messy business of implementing all of these changes have yet to start. Cutting taxes and spending money is great but will that not add more debt to a heavily indebted economy and be somewhat inflationary given how low current unemployment is in the USA? The bond market certainly thinks so as the yields on US bonds soared after the election (the so called Trump Tantrum!). Aren’t higher interest rates going to pose a challenge given huge existing debt levels?
Less regulation is great in the short term but we have seen that left to their own instincts, banks in particular have proven their willingness to put more value on short term profits than long term stability. Just like with Brexit, the “devil is in the details” of the implementation. As I said last summer, the UK and the EU have so far just agreed to separation but the divorce lawyers have yet to start negotiations and this will be messy and is still in front of us. It is in the best interests of the remaining 28 European Union members to punish the UK at every opportunity in order to dissuade other members from thinking about leaving the union. France and Germany have scheduled elections this year and a 2017 Italian election is very possible that could end up being a referendum on continued EU membership.
Renegotiating trade deals, threatening border taxes and bullying countries and companies in clever 140 character “tweets” is entertaining but it is not governing. One of my favorite expressions which many of you have heard probably more than once is that “nobody wants to see how the sausage gets made” and on many different fronts, we are going to see lots of sausage get made in a very public manner. These next four years are going to be anything but boring as we transition to more volatility, higher interest rates, higher inflation levels, and heightened trading tensions or outright conflicts. Active investment management is going to provide more opportunities and a wider range of outcomes going forward.
As always, please remain seated with your seatbelt fastened at all times!