Reflecting on a turbulent past

Not only is the last day of the year but it is also the end of a long and troubled decade and as usual at this time of year I want to spend a little time looking back. Looking first at 2019, how did I do in terms of my big calls?

2019 in review

In terms of the economics, I did broadly OK, arguing at the start of the year that “it is unlikely that we will see recessions in any of the world’s major economies this year.” That said, it was a bit touch-and-go in Germany for a while and the euro zone economy slowed by more than I anticipated, largely because the US-China trade dispute caused more damage to Europe than expected. Indeed, the global economy felt a bit softer than we had hoped, partly due to trade issues but perhaps because the economic expansion in place for the last decade is long in the tooth.

Whilst I was overly optimistic on the economy, I vastly underestimated the markets’ capacity to defy gravity. We have seen double digit rates of return across the equity space, with key US markets up by more than 25% year-to-date although over a two-year horizon, the gain is only around 20% (chart). I could kick myself for missing out on that opportunity but I’d probably miss! Monetary policy was the driving force here, with Fed rate cuts that were not foreseen at the start of the year giving markets a shot in the arm. Although I hold to my view that equity markets are overvalued, increasingly we cannot look at individual asset markets in isolation. Investors continue to pile into equities because the alternatives are dire. When large parts of the fixed income universe are yielding negative returns, there is every incentive to chase the higher dividend yields generated by equities – not to mention the prospect of a decent capital gain.

As for politics, I was right in predicting that the UK would not leave the EU without a deal, but that was a long and tortuous process that nobody wants to repeat. But I was wrong in suggesting that “impeachment proceedings will not be initiated against Trump”. Clearly the Democrats believe that the political calculus has changed and that it is worth their while to follow through, even though their chances of removing President Trump from office appear slim. And finally in terms of my 2019 predictions, I did not see the emergence of Christine Lagarde as ECB President, but I was glad to see that the BoE did indeed “look no further than FCA Chief Executive Andrew Bailey” in finding a successor to Mark Carney.

The 2010s in context

This being the last day of the decade, it is worthwhile examining how far we have travelled in the past 10 years. At the end of 2009 we were coming off the back of the biggest peacetime economic collapse in 80 years. The outlook for the year ahead was not especially bright but the general belief was that within a few years growth would recover to pre-crisis trends and that monetary policy would slowly normalise. Neither of these things has happened in Europe.

Although European politicians are reluctant to admit it, we are experiencing a form of Japanification. One of the defining features of the post-bubble Japanese economy was that the slowdown in population growth occurred at the same time as policy makers were struggling to cope with the after-effects of the bubble. This meant that they did not notice the slowdown in trend growth until it was too late. In Europe, baby boomers have retired in droves over the past decade, with the result that the contribution to potential growth from labour has diminished and in the absence of a boost from capital investment, European potential growth is now much slower than before the financial crisis.

However, this does not justify holding interest rates near zero for so long (let alone in negative territory as the ECB has done). I maintain, as I have done for a long time, that the costs of this policy will ultimately outweigh the benefits (if they haven't already). Over the next decade, we will feel the costs in terms of our nugatory pensions. And I continue to wonder whether part of the reason for weak investment activity is because low interest rates mean low rates of financial return.

But the biggest change over the past decade has been in the political field. Nationalism is the order of the day in many parts of the world and finds its most obvious expression in the form of Trump and Brexit but it is bubbling away across Europe and Asia. A decade ago, Barack Obama was the cool president for a new America but in less than a decade he was replaced by an angry populist with plenty to say but no clear policy ideas. Similarly, Grexit was starting to rise up the worry list a decade ago but it is the UK which is about to leave the EU.

As I have noted before, both these issues reflect the failure of centrist politics. Politicians overpromised and under-delivered in the wake of the crash but electorates now want leaders who will take action rather than offering jam to tomorrow. Unfortunately the issues we face are more complex than politicians are prepared to admit in public. Demographics are changing the face of European economies and will force politicians to take some hard choices when it comes to allocating resources. The rise of China has also changed the political calculus in the US and Europe and will continue to shape world events in the 2020s.

If you have read this far, however, thanks for sticking with it and congratulations on surviving another year - indeed another decade. I wish you all a peaceful and prosperous New Year.