Lesson #1 – the madness of crowds
The multiplying frenzy surrounding bitcoin is being fed by little more than price momentum. There has been no commensurate (or even perceptible) change in the fundamental prospects of the crypto-currency this year. We continue to argue that unless bitcoin finds itself a role in the global economy, its intrinsic value is essentially zero. We still see this role as elusive, and see the arguments behind the idea of a future ‘bitcoin standard’, as economically illiterate. However, fear of missing out can be a powerful force in investments when market values move as fast and as far as bitcoin’s has in the last several years. Bitcoin does not yet fulfil any of the criteria that we would look for in an investible asset and we would continue to advise extreme caution. Most boxes on the bubble checklist are already ticked, now all we await is a catalyst to spur the rout. This melee also serves to provide contrast to the other areas of the world’s capital markets that are apparently in bubble territory. Bonds are expensive, but we still expect most to be paid back at par. Meanwhile equity market valuations are also above long term averages, but with perhaps greater justification than is generally realised. Neither asset classes fit the description nor feel of a bubble.
Lesson #2 – Politics (still) doesn’t always matter
This was another year in which political bark and bite didn’t match up. The themes that dominated many outlook documents at the start of the year were protectionism, populism and the end of globalisation. French elections were seen as just another staging post in the inexorable return of nativist politics. Europe and emerging markets were generally seen as no-go zones by many investors as a result. In the event, European and Asian emerging market equities have been two of the stellar performers of the year so far. A sharp cyclical pick-up in global trade has been an important input into that story. Ironically, this pick-up is in large part down to the strength of US consumption, where trends in global trade tend to be forged. None of this is to argue that politics can’t be influential. However, we need to be wary of the priority many seem to routinely give to political events with regard to investment returns. We are not political strategists and cannot pretend to be able to be able to scent the changes in socio-political direction quicker or better than anyone else. The work that we have done over the last few years has instead focused on the constitutional restraints – what and how much could a particular protagonist, or group of protagonists, actually do within the confines of the various constitutions if they did make it into office? For the most part, our (admittedly guarded) faith in these restraints, alongside a degree of economic self-interest, continues to be rewarded.
Lesson #3 – The difficulties of forecasting inflation
We’ve long argued that the relationship between growth and inflation is a loose one, an idea that this year has served to reinforce. Growth has accelerated, unemployment in the developed world is close to three-decade lows, and yet still wages remain muted and the wider forces of inflation in abeyance. For our part, we do continue to see those forces slowly gathering in coming years, amidst that diminishing economic headroom. However, it remains very difficult to pin down precisely how much slack remains; from poor and incomplete labour market data to the difficulties inherent in measuring productivity in the modern, services dominated, world, it is easy to understand why an accurate estimation of output gaps eludes even the planet’s greatest minds. What we can say is that there is probably less slack than there was a year ago, and if the world economy continues on its current trajectory, the same will be true of next year. All this is important, as the main risk to our still benign outlook for markets is a sharper than currently forecast inflation pickup. We do not want central bankers hurried as they try to delicately untangle themselves from the extreme, and successful, monetary experiments of the post-crisis period.
These are obviously not the only lessons to be learnt this year; markets are always teaching us humility for one thing. However, these three are likely to be helpful for us all to remember as we go into another year with a crowded political calendar and a few more grey hairs.