Looking at 2015

Looking at 2015

Posted on 24 December 2014
"After all, markets are a complex cocktail of macroeconomic, microeconomic, industry and company specific drivers, sprinkled with emotions, all of which influence prices."
The promulgation of market and economic outlooks is a seasonal exercise. More often than not, these are a compendium of forecasts that attempts to place into focus the inherently fuzzy picture of what the future holds. The problem with outlooks is that they tend to define the future when in reality all they can do is define a future. If the arch of history has taught its students anything, it is that many futures are possible, depending on the course events take.
Attempting to forecast growth with real accuracy in a $17 trillion economy with more than 330 million people engaging in billions of transactions, like the US, is a herculean task. Expanding the exercise to forecast a roughly $75 trillion global economy with over seven billion people engaging in trillions of transactions – some rational, many not – and the challenge is compounded.[1] To do so with any consistent accuracy amounts to a modelling miracle yet to be achieved, despite the parabolic increase in computing power. After all, markets are a complex cocktail of macroeconomic, microeconomic, industry and company specific drivers, sprinkled with emotions, all of which influence prices.
So we approach this exercise with modesty, indeed humility. Our aim is to define the shape of things that might come and how that state might be influenced. Correctly identifying the direction and general level of markets and economies constitutes success, rather than a point forecast for any asset class, market or economy.
In our latest edition of Compass, we attempt to identify the larger forces in play on matters economic and financial. Some of these forces are clearly discernible, in fact hard to avoid; others are subtle but exert equally important influences on the velocity of markets’ growth and the economies in which they operate. Think of them as subject themes that investors should firmly root themselves in, as these themes will likely repeatedly exert themselves during the year ahead. Most of the themes are actionable within a portfolio context or in an opportunistic way. Either way, the idea is to lay the foundation for further investigation and consideration by investors over the months ahead as the vicissitudes of fortune unfold. The Outlook edition of Compass focuses on five themes:

1. Energy:

Energy prices have dominated the headlines in the closing months of 2014 as concerns about demand and supply have battered prices in the energy complex. While the causes of the drop and forecasts about the future direction of energy prices are topics of hot debate, our examination points to a much more nuanced picture. As we point out in “Oil: Will Saudi Arabia stay the course?” the drivers of energy prices are myriad and include geopolitics, new energy technology, global consumer demand and the product supply of OPEC and non-OPEC producers.[2] Despite the clarion call from the financial commentariat, we do not subscribe to the point of view that low prices are here to stay.

2. The coupling and decoupling of global economies:

Talk of a synchronicity of global economic activity ebbs and flows with the global growth backdrop. The question of the geosynchronous path of economic activity is never far from conversations about the post-“Great Recession” period in which weak players got weaker and stronger players stumbled and have recovered to varying degrees. The bottom line is that the growth vectors of countries around the globe are a product of many things. Common among them is the evolving state of the financial system. The importance of a healthy system of credit is not a Victorian notion of high finance. It is an elemental part of any robust capitalist economy.
The “Great Recession” was essentially the product of a bubble in credit facilitated, in no small part, by the institutions that extend credit. As might be expected in the post-bust economy, attempts to rectify structural deficits in the financial system have manifested themselves on the economies in which they operate. Remediation, whether financial or otherwise, has a cost. In our essay, “Global flows: Integrate or isolate,” we attempt to evaluate this remediation of
structural problems in the financial system and the attendant costs to global economic activity.

3. The problem with productivity:

Economic growth is inextricably tied to productivity. Despite the heroic exertions of the world’s central banks and the countries they operate in, global growth has been frustratingly anaemic. To understand a fundamental reason for this weakness, one must look at the lack of productivity growth. Examining the drivers of productivity can be easily waved off as the province of academics and economists, but this would be a freshman mistake on the part of investors. Productivity is to economic growth as credit is to a capitalist economy – they are both the lifeblood of each. In our article, “Productivity: The elephant in the room?” we look at its components and what influences it. For policymakers in developed and developing countries alike, understanding their problems with productivity is critical if they are to set their respective economies on a better and durable trajectory.

4. A central banker’s game:

We are in the age of the central banker. The person with the printing press generally wins, and central bankers have used their respective printing presses with an alacrity not seen in generations. As global economies move beyond the crises of the last seven years, divergent monetary policies are emerging. The United States is striking off in its own direction as the metrics that the Federal Reserve used to support quantitative easing and a zero interest rate policy are suggesting that a change in policy should be in the wings. In “Inflation and bonds: A central bank balancing act,” we examine the metrics of easy money and the current posture for interest rates as the “Great Divergence” in central banking is set to begin.

5. The insight or madness of crowds:

The proponents and opponents of crowd behaviour are adamant in their belief of the value that group behaviour conveys. Proponents of the efficient market believe the prices conveyed in public markets essentially reflect all there is to know about the underlying value of a security. In other words, the wisdom of the crowd manifested in the market reflects the best and, perhaps, most complete insight into the price-value relationship. Sceptics, on the other hand, have a constitutional aversion to the crowd consensus. Consensus opinions are comfortable places to be, as they reduce career risk and enjoy the warm embrace of others holding the same views. It is easier to be completely wrong as long as you are in good company than to be alone and similarly in error. In “2015 equity markets: More surprises in store?” we examine the consensus views of 2014 – the good, bad, and completely wrong – and we contemplate equity markets in 2015.
Read the full edition of Compass on our website.
As always, we hope you enjoy the contents and welcome your thoughts, observations, and comments. We hope your holiday season is safe and satisfying, and we look forward to another prosperous year in 2015 – for the discriminating investor.

[1] Bloomberg, as of 4 December 2014.
[2] The Organization of the Petroleum Exporting Countries.
Hans Olsen, CFA Global Head of Investment Strategy

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