2017 Outlook: Part 2 – As you were
By Paul Gambles, MBMG Investment Advisory
As was the case with 2016, we are in tumultuous times. So how can we navigate these treacherous waters? Some people believe that a permanent structural adjustment took place during the 1970s and 1980s, which justifies the divergence from centuries of data. Personally, I don't – which means that we should expect to see property fall in value by up to 70% while equities fall in value by up to 90%.
But even if the structural adjustment argument is right and the clock had been re-set at the start of 2001, then over the next 15 years this would imply the following:
1) Property to do little better than remain flat in nominal terms and lose over 20% of its inflation-adjusted value.
2) U.S. equities to increase by around 2% per year in nominal terms and pretty much go nowhere in inflation-adjusted terms.
3) U.S. 10-year Treasury interest rates returning to over 5%.
The ranges between best and worst cases for property, equity and bonds imply limited or no upside in the best outcomes and appalling downside in the worst. Buying and holding any asset class just isn't an option any more.
The scale of downside volatility looms so large that it should be seen as an opportunity to generate returns – not just a threat against which portfolios have to be protected.
Trend-following or commodity trading adviser (CTA) funds tend to exhibit uncorrelated returns in markets where equities, commodities or property go up in value (i.e. sometimes they go up too, sometimes they don't). But they exhibit an extremely strong negative correlation when these asset classes crash.
Other risk-adjusted attractive propositions include equity funds that mitigate the risk by some form of insurance.
Although treasuries look to have a bleak long-term future, they do provide diversification against equity risk. Also, at a 2016 average yield of around 1.8% on the 10-year US bonds, they do have short-to-medium-term upside potential. As does a weaker sterling: GBP-hedged U.S. Government Bond Index Funds are a great way to insure against a weaker dollar, stemming from a more-dovish-than-expected Federal Reserve. Gold has also fallen back to levels where it would benefit from a backtracking Fed.
The risk and reward of all asset classes is a constant state of flux but arguably never so violently as now. A fixed allocation today to a winning 5-year strategy may not be possible without taking excessive risk. But a strategy built on today's pricing, where many assets have asymmetrical risk/reward profiles (much more downside than upside), means that investors need to combine non-traditional investment strategies and methodologies with a constant ever-changing lookout for assets whose pricing – like gold, treasuries and sterling right now – may be at or approaching something much more like fair value (see charts). Thus, making that risk/reward outlook at least more symmetrical, if not actually skewed in your favour rather than against you.
In other words, most traditional asset classes offer, at best, marginal-to-flat real returns for what appears to be the next decade-and-a-half. At worst, they offer the risk of a correction that, in the case of property, commodities and equities, could easily exceed 50% and could remain at much lower levels than today for decades to come. This has gone from a distinct possibility to a base case for risk and return. I don’t believe that, in general, the election of Donald Trump has done anything to change this. What it has done, though, is skew risk and reward in certain assets and asset classes.
As I stated a year ago, I would make the point that for all the possible outcomes it’s important to remember that we’re starting from where we are today.
In this case, we’re now starting a New Year with a new US President and this has led to an unprecedented swathe of predictions about the markets and economics in the year ahead. But, in terms of the economic situation at any rate, the new presidency like the forthcoming 12 months, is merely a continuation of the presidency and the year just passed. Just as nobody rings a bell at the top of the market, the bells that we ring to signal in the New Year have no other significance except perhaps behaviourally as a time to take stock; as one of the legendary stock speculators of the 1920s and 1930s apparently did over each New Year. The story goes that he used to lock himself in the vault of his bank amongst all the bank’s cash and holdings to study his stock trading records for the year just finished.
It remains the case that the causes of events like the GFC were built up over many prior years; but in 2006 there were clear symptoms that the plaster which had been applied in 2002 was unable to staunch the wound. Most markets actually peaked in late 2007 but the crisis only became apparent in 2008 and in many markets bottomed in 2009. I’ve often stated that it’s impossible before the event to state exactly when, where and how bubbles will be pricked.
We can only observe the vulnerability of the bubble itself. A year ago it felt as though the significant, but not yet absolutely critical (with possible notable exceptions such as China), debt bubble in most parts of the world was a major cause for concern; and that there remained determination (and the tools to allow this) among policymakers to continue to stabilize the instability of the financial system, by protecting the bubble for as long, and to as great an extent, as possible. Government debt monetization, such as infrastructure investment espoused by both US Presidential candidates, still remains the next likely phase of this process and could kick the debt-deflation can further down the road for several years to come.
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Paul GamblesMBMG Group, Bangkok, Thailand
T: +66 2 665 2536
Paul Gambles is co-founder and managing partner. He is licensed by the Thai SEC as both a Securities Fundamental Investment Analyst and an Investment Planner. Paul is also well-known as an expert commentator, appearing regularly on Bloomberg TV, CNBC and Channel News Asia. He also writes the weekly newsletter MBMG Markets Flash, regular Updates and articles.
MBMG Group was founded in Asia in 1996 and has since grown steadily. It offers services ranging from investment advisory, corporate advisory, tax advisory, family office, accounting and audit, legal, insurance, estate planning and property solutions.
Published: January 2017 l Photo: Jeffrey Daly - Fotolia.com