Economist John Kenneth Galbraith once said there are two kinds of forecasters: those who don’t know and those who don’t know they don’t know. Yet every year, strategists and commentators go through a New Year’s ritual of making bold, often mistaken predictions about the economy, markets, and geopolitics. Given their poor track record, a cynic would call this a useless exercise. But a more positive view is that predictions do us good by forcing us to review consensus thinking and imagine some crazy unanticipated surprises. After all, investment success comes from seeing what the crowd isn’t expecting.
Consensus views may be changing rapidly in light of the turmoil we’ve seen the first two weeks of 2016. As of this writing, the S&P 500 is down 8% for the year – the worst start in history. Developed foreign markets are down slightly more, and emerging markets are down close to 11%. These are the kind of numbers that bring on rapid re-evaluation of risk.
Nevertheless, the consensus still seems to hold that the U.S. will remain the best neighborhood in the globe and that the dollar will stay strong. The U.S. market has far outperformed the rest of the world since the financial crisis and even though earnings forecasts are coming down, more of the same is expected. The Wall Street Journal’s survey of economists sees U.S. growth in the mid-2% range. Inflation is expected to stay tame.
It is the rest of the world that is troubling. China remains the big question mark (see Eric’s article). Europe is dawdling economically and facing a migrant crisis. And perhaps most frightening are plummeting oil prices, natural resource markets, and emerging markets, where currency devaluation has been extreme. While the consensus expects a modest bounce in oil, few expect significant recovery.
Nevertheless, it’s quite possible that what we expect may not come to pass at all. We don’t know what will happen, and neither does anyone else. But for us, three interesting contrary possibilities to consider include:
1) The dollar weakens instead of strengthens. Why? The dollar has had a great run, and high expectations may already be priced in. The Economist notes that the Fed may not get to tighten as much as was expected this year. A softer than expected U.S. stock market also could reduce demand for dollars versus the euro and yen.
2) Commodity prices stabilize. The cure for low commodity prices is...low prices...because that’s what drives production cuts, which eventually lead to higher prices. The pain may be getting intense enough that this is beginning, and it will be disruptive for weak producers. But for things to look better prices don’t have to soar -- they just need to stabilize.
3) Emerging markets do better than expected. After six years of severe underperformance, The Economist notes that pessimists on emerging markets outnumber optimists by a wide margin -- a sign that price levels have reached extremes. Strategist Byron Wien, in his annual 10 surprises, wrote that emerging markets could “astonish everyone by becoming positive performers in 2016.”
There are plenty of other interesting predictions out there, from Japan and Silicon Valley to London real estate. But there is one possible surprise worth leaving as a final thought: Things may not be as bad as you think.
It’s been an awful start to 2016 – extremely painful. But remember how early 2009 felt? Remember the idea of Grexit and Europe disintegrating over 2011-2012 -- and the wall of worry over the U.S. losing its triple A credit rating?
Well, actually you probably don’t. In awful moments, you may think the world is coming to an end, but it doesn’t, and the pain doesn’t last forever either. Then you forget what it felt like when you were thinking those “sky-is-falling” thoughts. So take a moment, breathe deeply, and put aside the pain to think clearly. Then perhaps consider another humorous quote from John Kenneth Galbraith about how the world surprises us: “In economics, the majority is always wrong.”