A lot of the lessons learned from 2016 have been painful, particularly the triumph of visceral voters in the UK and then the US over rational ones. They’ve been well covered, to say the least, but the quality of forward looking prediction has been a great deal less reliable than the “here and now” analysis.
1. Ignore the pundits where you can.
The pollsters have discovered the dangers of predicting poll outcomes in countries where voting is voluntary. They now understand, too late, that the supposed percentage probability of a certain outcome is actually a guess, cleverly disguised as a tangible number. And meanwhile, developed country equity markets were supposed to drop by around 10 per cent if Donald Trump won the US Presidential election, according to many supposedly wise heads. Instead of which the Dow ran up to a new record thanks to Trump’s plan for a mega-spend on infrastructure.
What that means for investors is that they should ignore share market “noise” as it may well be wrong. Most particularly, they should not sell after that sort of negative prediction, because they might well miss an uptick in the market. An exception to that is that the best time to buy shares is at times of maximum uncertainty, as there will be nervous (if possibly misguided) sellers around.
2. Political promises are now worth less than they ever were.
The market’s enthusiasm for new US government spending is in marked contrast to the mood at the end of 2012 when some Republicans were prepared to paralyse the whole process of government rather than agree to raise the cap on borrowing limits.
It’s a bigger version of Joe Hockey’s so called “Budget Emergency” that loomed just before Tony Abbott’s Coalition government was voted in in September 2013. The sums involved are so big that most voters’ eyes glaze over. To judge by how those events have been conveniently forgotten, the political leaders in the US and Australia might well be hoping voters’ memories are as wonky as their comprehension of big numbers. Conclusion: some pollies are taking us for mugs, more than ever.
Investors should remember that politicians have less control over the “real” economy in most developed countries because central banks are now much more independent than they were. Central banks control the interest rate lever and that has the most immediate effect on prices. A rise in rates will only follow a run of potentially inflationary news, and the only whiff of inflation is coming from Trump’s big spending plans, which may or may not happen.
3. The laws of supply and demand have not gone away.
Trump may have lied his way to the Presidency and that stupid poster about the 350 million pounds the UK was sending every week to Europe has now been exposed as a total distortion, given that it discounted the money flow the other way.
But the lift in price enjoyed by iron ore and coal since the start of the year thanks to Chinese demand is entirely real. Iron ore is now around $US80 a tonne, which at current exchange rates is well over $A100, while the price of some types of coal has spiked well over 100 per cent since the start of the year.
That’s a more prickly one since China’s already said its demand for steel is dropping, and steel needs both ingredients, but you can’t argue with a current price of over $100 a tonne for steaming coal (used in power stations) and around $US200 a tonne for the metallurgical coal used in steelmaking. The latter was below $US80 a tonne in February.
So what’s happening there? China produces both iron ore and coal domestically but the quality of both is much lower than what Australia exports. When global prices are low, as they were in January, a lot of capacity gets mothballed in favour of higher quality imports and there’s inevitably a time lag between spot prices picking up, and domestic mines being recommissioned.
Where’s it heading? The industry says that the iron ore price is bound to drop back to around $US80 or below once Chinese speculators get carted out of the trade.
That price, meanwhile, is still cherry pie for our local producers, not to mention the Australian Tax Office which can look forward to higher than expected tax receipts from unexpected windfall profits.
Conclusion for investors? Single product bulk commodity stocks are now, more than ever, for trading rather than simply “buying and holding”. I’ve just bought some BHP shares as a longer term play but BHP has a suite of different products, so it’s not so volatile. The small iron ore producers are highly leveraged to the iron ore price and you’d have to be more confident than most, including the Chinese authorities, to have a major lash in that area.
4. What goes down must come up, and vice versa.
The super-low interest rates of the last couple of years are going to have to come to an end at some point as they distort economic activity. The Organisation for Economic Cooperation and Development in Paris, the OECD, recently noted that interest rates in a number of countries including Australia will have to rise because of the excessive effect that cheap loans are having on property prices. Maybe the unlovely Mr Trump has done us a favour by causing the market to price interest rates higher thanks to his plans to borrow vast amounts of money to rebuild US infrastructure. Someone had to ring the bell.
Conclusion for investors? Fixed interest rates are rising, which means bond prices are falling. The usual tendency in markets is that high fixed interest rates draw investors away from the share market, but to be honest there’s still a big gap between the still-low fixed interest returns and dividend yields, particularly when you had in franking credits. The only casualties of higher interest rates are the investors who up to the gunwales in bonds, but that does emphatically NOT include most Australian investors.
All of this means that markets will remain uncertain. I was in Hong Kong a couple of weeks ago at an event where a senior executive in the financial services industry laughed at someone whingeing about how markets at the moment are uncertain.
“Markets are always uncertain and that’s what gets me out of bed in the morning,’’ he said. “I want to know what’s going to happen.”
“I shudder to think how dull my job would be if I knew in advance what the day was going to bring.’’
He had a point. So, if you can, ignore the noise but assume there will always be the unexpected in markets. We don’t know exactly where we are going but every day’s a new day, and the balance of probabilities says that over the long term, equity markets will outperform most other asset classes and IPOs will outperform equity markets.
