Year ahead 2024: 2023 with a twist

They say an optimist is someone who stays up until midnight to see the new year in, whereas a pessimist stays up to make sure that the old year is finally gone. It’s an apt description of where we find ourselves now, for many of the economic and political issues we were discussing in late-2023 will still be high on the agenda in 2024.

The economics

As we look ahead, it is briefly worth reflecting on how we did in 2023 to assess whether there are lessons for our year-ahead predictions. For my part, I give myself a pass on the inflation view although it perhaps decelerated even more rapidly than I anticipated. In my year-ahead predictions a year ago I suggested that “calls for interest rate cuts will build. Central banks are unlikely to heed these calls, and maintain policy tighter than might be justified by economic conditions.” That is not too far off the mark: There are concerns in the euro area and the UK that central bank tightening has gone too far, which in turn is crimping growth and is setting us up for a difficult 2024. Markets are convinced that central banks will cut rates as inflation remain quiescent – a view with which I agree although it will not be sufficient to give much of a growth boost this year.

Indeed, although my suggestion that the industrialised world would experience a recession in 2023 proved wide of the mark, we are far from out of the woods. The energy price shock was expected to be a catalyst for a growth slowdown a year ago but in the event both the US and European economies avoided the worst case outcomes. Today, however, the catalyst is more likely to be the lagged effects of monetary tightening over the past two years. Real interest rates in the US and Europe turned positive in late-2023 and are likely to remain relatively high over the first half of 2024. In addition, many firms and households have been protected from the full impact of recent rate hikes by fixed-rate borrowing agreements. US property investors and UK households whose fixed-rate deals have to be renewed in 2024 could find themselves having to shell out considerably more in debt servicing costs, which will take the edge off activity. Whether or not the US or UK experiences a recession is less important than the likelihood that growth will be considerably slower in 2024 than in 2023.

The outlook for the Chinese economy will play a crucial role in determining the global growth outcome. It is becoming more evident that the old playbook of throwing money at an economy suffering from years of investment misallocation will no longer work. Bubbles in the property market, with the near-collapse of Evergrande and the default of Country Garden, are symptomatic of a bubble economy gone wrong. With demographics increasingly not running in China’s favour, and the population declining in 2022 for the first time since 1961, dare we whisper it but China is suffering from many of the symptoms of the Japanese bubble economy of the early-1990s. The economy will not collapse any time soon, but we should get used to annual growth with a 4-handle rather than something bigger than six.

And the politics

2024 is shaping up to be a big year for elections and they do not come any bigger than the US Presidential election which takes place in November. It seems almost certain that we will see a rematch of Trump versus Biden, barring the intervention of the courts or unforeseen health issues. I would not like to put my money on who will win, although for the record the bookies currently offer shorter odds on Trump. However, one thing is certain: This will be one of the nastiest election campaigns ever fought. It is not too much of an overstatement to suggest that the future of the western alliance hinges on Biden getting back into the White House. Europe has already experienced the capricious nature of Trump’s foreign policy and America’s global standing would not emerge well from a second Trump presidency if he uses his term to settle old scores.

This is particularly problematic in view of rising geopolitical tensions: The Russia-Ukraine war will enter its third year in February and a Trump presidency would seriously imperil the flow of materiel to Ukraine (although this would likely only become an issue in 2025). Similarly, the Israel-Hamas war will require deft diplomacy to prevent it spilling over into a wider regional conflict. Just because it did not immediately ignite following the events of October 2023 does not mean that the risk of a wider war in 2024 can be ignored. Then there is the China-Taiwan problem. Later this month, the Taiwanese presidential election is expected to see Lai Ching-te (aka William Lai) of the Democratic Progressive Party elected to the presidency. In the past Lai has been aggressively pro-Taiwan (and by definition, anti-China). Although he is likely to be more circumspect in his comments as president, he is distrusted by China and we can expect a ratcheting up of pressure from Beijing. This will be a further headache for the US policy establishment, which will be distracted by electoral considerations in 2024.

The US election is not the only game in town: There will also be plebiscites in a number of important economies such as India, Indonesia and South Korea. It is also highly likely that there will be an election in the UK. Although legally it does not have to take place until January 2025, the smart money is on an autumn 2024 election with one prominent Labour politician recently suggesting that it was “the worst kept secret in Westminster” that a contest would be called for May. The result is rather easier to call than in the US – there is almost certain to be a change of government in the UK in 2024. Much of the discussion centres on how big Labour’s majority will be. Electoral Calculus reckons that Labour will gain a 133 seat majority which would be way bigger than Tony Blair’s government achieved in the 1997 landslide win (an 88 seat majority). For the record, I do not think that Labour will come remotely close to such a majority. In order for this to happen, the Conservatives’ vote would have to halve and Labour’s spike to record highs. I would be amazed if the majority is as high as 50 and would not be surprised if it was as low as 10 seats.

Markets in 2024

2023 was a better year for investors than 2022, when returns on both bonds and equities were negative. A so-so 2023 was transformed in the last couple of months when the S&P500 rallied by 14%, delivering a 27% return for the year – the best since 2019. Global fixed income also ended the year up 6%, having been down 4% in mid-October. The catalyst for the surge was expectations of US rate cuts in 2024 which, if delivered in line with expectations, suggests that most of the good news is already in the price. Doubtless the momentum will continue over the early weeks of 2024 and markets will exult that bonds really are back. If the US economy manages a soft landing, as is increasingly anticipated, there is scope for equities to go higher still. My own view, for what it is worth, is that the bulk of the gains will be generated in the first half and it may pay to go defensive later in the year as the rally runs out of steam.

What else?

AI was one of the buzzwords of 2023 and there will be further developments in 2024. Although ChatGPT proved to be a phenomenal success, and was one of the catalysts behind the rally in US stocks, its ability to generate plausible-sounding feedback that is often untrue means that corporates remain wary of its full-scale adoption. New iterations of LLMs are likely to be released in 2024 which will offer significant improvements in information veracity and verifiability. This in turn may encourage more widespread adoption. Reports that OpenAI is working on a powerful new tool known as Q* may take AI to another level. Nobody knows for sure what Q* is, or how it works, but these posts (here and here) suggest that it could herald a revolutionary breakthrough in the way AI handles mathematical problems. This will open up a whole new range of applications and intensify the debate about how much control we are prepared to cede to the machines.

While on the subject of matters tech, one thing to look out for in 2024 is the prospect that Twitter (sorry, X) goes bust. As I pointed out in April 2022 “the financials of Musk’s Twitter deal do not look compelling.” They look a lot less compelling today, with Musk desperate to turn a profit on his ill-advised venture into social media. As usage numbers fall and advertisers desert the platform, it would come as no surprise if Musk were to seek a buyer at a knock-down price, especially as Tesla is no longer pulling up trees when it comes to its own finances.

But as I have been telling investors for years, it’s the unknown unknowns that get you. The whole narrative could be thrown off course by a random event (Covid or Russian invasion, anyone?) so it pays to take year-ahead predictions with a big pinch of salt. As long as they are not blown off-course before end-January, I will be happy. And on that note, I will end by wishing you all a happy and prosperous new year.

Outlook 2022: Covid and all that

As we head into the third year of the pandemic, Covid will dominate the headlines again in 2022. There are three possible outcomes: things get worse, they get better or they stay the same (how’s that for insight?). Whilst this may be a statement of the obvious, whichever path we are on will have profound consequences for the economy and outlook for financial markets through the course of 2022 and beyond. Since it is impossible to predict how the disease will evolve, it is worthwhile setting out a few scenarios to assess the range of possibilities.

Case 1: The Covid situation gets worse

In the case where a much more virulent strain emerges, we could quickly find ourselves back in the same situation as 2020 with stringent lockdowns and a big hit to the economy. Unlike 2020, however, we will not be facing a totally new threat; we have experienced Covid waves before and the initial reaction from governments will be to impose fewer restrictions than in March 2020. Accordingly, the initial hit to the economy may be less dramatic. But if the emergent strain proves to be more deadly, there will be a significant hit to confidence and the economy may not rebound quickly as people realise that the pandemic is far from over. In such a case, governments and central banks will be forced to open the taps once again, despite the recent surge in inflation, which will continue to put a floor under markets with equities pushing on to new highs.

Case 2: More of the same

A repeat of the 2021 pattern would see a huge rise in cases at the start of the year as the Omicron variant works its way through, followed by a dip during the spring and summer before another less virulent strain emerges in the autumn. Such an outcome would likely mean an uneven recovery with decent but not stellar growth in the spring and summer and a slowdown over the winter months. Covid restrictions would likely be eased in the first half of the year but, as case numbers mount, continued pressure on health services suggest restrictions will be tightened later in the year which would particularly affect sectors such as hospitality as a quasi-lockdown is implemented. In this environment central banks can be expected to ease back on the monetary throttle to curb inflation in the first half of the year but stand pat in the second half, taking some steam out of markets which push ahead relatively slowly.

Case 3: Omicron proves to be the last hurrah for Covid

In the best case scenario, Omicron is the precursor to the emergence of a much milder form of Covid which becomes an endemic problem rather like flu. Economic growth settles towards trend rates and central banks can afford to be more aggressive in tightening policy. However, high inflation in general and rising energy prices in particular will act as a drag on household incomes, with the result that even in this environment GDP growth remains relatively slow. Against that households may run down some of the excess savings accumulated during the pandemic which will act as a growth support. Inflation is likely to slow as supply issues are largely eliminated by end-year and markets lose momentum in the face of higher interest rates and less dynamic growth. We may even start to hear talk of excess supply and disinflation before the year is out.

Politics and geopolitics are back on the agenda

After two years in which the world has been preoccupied with managing domestic pandemic issues, global geopolitical issues are a matter of urgency for western leaders who are increasingly concerned about a more assertive Russia and China. Russian troops have recently been building up along the Ukrainian border and the US has expressed concerns that this could be a prelude to invasion. We have been here before, of course. Last April, Russia built up troop numbers close to the border only to pull back, so latest moves might simply be another chapter in Vladimir Putin’s power play. But they may not, and in the event of invasion there is very little militarily that the west can do in response. The US has talked of unprecedented sanctions, which the Russians would counter by weaponising gas exports. At a time when European gas supplies are in a parlous state, this could have significant consequences for global energy markets.

President Xi Jinping is the most powerful Chinese leader since Mao and sits at the head of a country determined to regain what it sees as its rightful position at the top table. Unlike in Mao’s era it now has the financial and military clout to back up its ambitions. Recent years have demonstrated that China has no interest in living within the strictures of the western-dominated economic architecture, as its behaviour at COP26 demonstrated, and it continues to make threatening noises regarding Taiwan. Unlike Russia, China has no need to throw its weight around to demonstrate its power. But like Russia, it is increasingly seen as a competitor to western interests and the failed policy in Afghanistan, culminating in the shambolic withdrawal in 2021, will only encourage China to press at the west’s weak spots in 2022 and beyond, leading to even more fraught relations.

Here in Europe, Emmanuel Macron will face his biggest test as he gears up for the French presidential election. Despite poor approval ratings, the polls suggest he will easily make it into the second round where he will face a runoff against either Marine Le Pen or Valérie Pécresse, the centre-right candidate of Les Républicains. The polls suggest he can beat either of them in the second round but the pollsters have been wrong before, notably in the German federal election last year which saw the SPD come from behind to beat the CDU into second place. Still, it would be a surprise if Macron were not re-elected to the Elysée Palace in April.

Another leader under pressure is Boris Johnson who faces mounting discontent amongst his backbench MPs. There has been speculation that a leadership challenge could emerge in 2022 which might happen if a combination of failed pandemic response policies and Brexit pain add to existing woes over political scandals. My own view is that Johnson will end the year in Downing Street. Ditching a third Tory leader in six years, before their term is up, will not play well with an electorate that appears increasingly restive, particularly when there is no obvious candidate to replace Johnson.

Markets: More upside but how much is already priced in?

There are good reasons to expect more upside for equities in 2022, albeit not at anything like the 2021 pace. Economic growth conditions remain favourable and earnings are projected to increase at a decent pace. A high inflation environment in the first half of the year may see a rotation towards inflation trades with gold appearing to be a natural beneficiary along with energy stocks. Up to three Fed interest rate hikes are expected in 2022 which may take the edge off equities, but an absence of Covid-related uncertainty would limit any downside.

Crypto will be one of the fascinating areas to watch this year. Bitcoin hit an all-time high above $67,566 in November and although it has since slipped below $43,500 it is too soon to write off the possibility that it can rally back above previous highs. Although concerns about the energy cost of mining persist, and China has recently cracked down on Bitcoin mining, there has been more widespread retail interest of late. Any wobbles in the equity market could certainly see renewed interest in crypto assets as investors hunt for yield. I maintain that the future of cryptocurrencies will depend on the extent to which central banks enter the field, and with the likes of the Bank of England and ECB looking seriously at the prospect of introducing a central bank digital currency, this may well place a floor under any downside for crypto assets in 2022.

What else?

There are a host of other themes that will move the needle in 2022. Environmental issues are one of them and the debate over how to manage climate change can be expected to make its presence felt. This has traditionally not featured much in near-term economic thinking but maybe 2022 will be the year that we pay more attention to the risks. 2022 is also World Cup year. Assuming it goes ahead, the tournament will start in Qatar in November rather than coinciding with the European summer, which will make things interesting. I am not going to pick a winner but with qualification yet to be completed I can confidently state that Portugal and Italy cannot both qualify.

As 2020 showed, unexpected events are the true enemy of forecasting and whatever happens this year, there will be some unexpected events that come out of left field. As Martin Luther King once remarked, “you don't have to see the whole staircase, just take the first step” which is a good way of saying that so long as our forecasts are not outdated before end-January, we can be reasonably satisfied.

The curse of interesting times

 

We have started 2021 where we left off last year with Covid by far and away the most important factor shaping events but US politics continuing to dominate the headlines. It seems we say every year that the coming twelve months are the most uncertain we can recall, but this time it really is true. In my view, whilst the US political reverberations will eventually fade the scars of Covid will prove longer lasting.

 

The ongoing impact of Covid

 

Not only do we not know what impact the 2020 Covid-induced collapse will have on the economy this year but matters are being complicated by a big rise in infections at the start of 2021. Although a vaccine is now being rolled out, the fact that many European countries are tightening lockdown restrictions in the early weeks of the year means that we will see bigger output contractions than previously supposed. It will thus take longer for many economies to get back on their feet and we are unlikely to see a significant turning of the economic tide before the spring.

Growth forecasts made at the end of last year are likely to be significantly revised down in the course of January. If the vaccine rollout proves to be successful, we can expect a strong recovery in the second half of the year. But if it does not go as planned (perhaps because the virus mutates faster than the vaccine can keep up or distribution proves to be slower) any recovery is likely to be muted. Indeed I can well foresee a situation where a significant recovery in UK GDP growth is postponed until 2022 and it is hard to see any circumstances in which output in the larger European economies will get back to pre-recession levels in the course of this year.

From a market perspective, the dominant theme will once again be the hunt for yield. Central banks have pumped huge amounts of liquidity into the global financial system and will continue to do so in 2021. As a result downward pressure on bond yields will remain in place, forcing investors into riskier assets such as equities. That said, concerns that Joe Biden’s economic plans will result in higher government spending and higher inflation might put a floor under bond yields. Whilst I have lost count of the number of times I have indicated that equities look expensive when measured on the basis of conventional metrics, I have also pointed out on numerous occasions that measures such as the P/E ratio are not especially informative when interest rates are so low. I will thus repeat my prediction from last year that in the absence of an unexpected shock, investors can be expected to continue buying equities.

The politics will remain interesting

There is a lot to look forward to on the political front. Although the Washington unrest is a big deal and will echo throughout the generations to come, its impact on the economy is likely to be limited. We can expect a less rumbustious tone from the White House as Joe Biden settles in as US President although today’s storming of the Capitol in Washington reminds us that the fault lines running through US politics will not easily be healed. Biden is likely to adopt a more conciliatory tone towards his European allies, thus reducing some of the strains in the western alliance which have been a feature of the last four years. Moreover, the Democrats have won control of the Senate following the run-off in Georgia after the indeterminate result in November. As a result, the Senate is split 50-50 which will allow Vice President Kamala Harris a casting vote. This in turn will allow the President a much better chance of pushing through some of his domestic legislative agenda since initiatives in areas such as healthcare, the environment and government reform are less likely to be blocked.

This does not necessarily mean that Biden will be able to push through his more ambitious programmes such as the Green New Deal but at least some of the Congressional logjam will ease. This may not be altogether good news for markets which liked the idea of a Democratic President but a Republican-controlled Senate as a check on some of Biden’s harder-to-swallow ideas, but it is unlikely to cause more than a temporary market wobble.

Here in Europe, Angela Merkel is not expected to contest the German election in the autumn after her decision two years ago to stand down as Chancellor. This would be a real game-changer not only for Germany but also for the EU. At home, Germany’s handling of the first wave of the pandemic was reflected in a significant surge in the opinion polls for the CDU and even though the polls have softened a little since the summer, its 35% share is still ten points higher than in March. Merkel has presided over a number of difficult issues during her 15 year tenure as Chancellor and is seen as the ultimate safe pair of hands. If she does depart the scene as expected, she will be a hard act to follow.

But Merkel will be particularly missed at the EU level. Since she took office in 2005 the character of the EU has changed immeasurably, following the scarring experience of the Greek debt crisis and the departure of the UK. One of the biggest future challenges faced by the EU is how to deal with the political difficulties posed by Poland and Hungary, which were newbie members when Merkel became Chancellor but are now running in a different direction to the rest of the EU. Merkel's trick has been her ability to smooth over those issues which pose challenges to the political integrity of the EU. Her successor will have their work cut out to deal with the politics so adeptly. Of course, there is still an outside chance that Merkel will change her mind and contest another election but I would not want to put money on it.

Not forgetting Brexit

And then there is Brexit to look forward to which from here on becomes an economic rather than political issue. The UK is now completely outside the orbit of the EU which will give us a chance to assess whether the much vaunted economic benefits will materialise this year. Things have not got off to a great start. Under new tax rules, which admittedly are not directly Brexit related, the UK now requires foreign mail-order sellers to register for UK VAT for any items sold to British customers. They are required to collect the tax on behalf of the government and pay the money to HM Revenue & Customs. A number of small businesses have decided that it is not worth the bother to continue shipping to the UK with Dutch Bike Bits arguing it was “ludicrous for one country” to insist on these conditions and it would, in future, “ship to every country in the world . . . except the UK”. There is also the small matter of this week’s collapse of share dealing in the City of London prompted by a large-scale shift in euro-denominated shares from London to exchanges such as Amsterdam and Paris. The sky may not have fallen in but these are indications of changed post-Brexit circumstances which we were promised would not happen. As the year unfolds, a number of unexpected consequences are likely to become manifest.

The year ahead will undoubtedly be a turbulent one. Maybe the departure of Trump from the political scene will allow some healing to take place in the US. But Covid is not about to disappear anytime soon and in so many ways, we are experiencing the curse of interesting times.

New year, new concerns

We have barely started the year and already a number of issues have surfaced which are likely to impact on the global macro picture. In the first instance, the decision by Donald Trump to order a missile strike that killed Iranian general Qassem Suleimani threatens further destabilisation in an already febrile Middle East. Markets reacted negatively, as is often the way with such events, and although nobody knows for sure what the longer term implications will be, this sort of provocative action has the potential to generate a spiral that nobody can control. At a time when the global economy has already lost momentum, a spike in uncertainty does not bode well for markets, although as I noted a few days ago, markets have developed a habit of defying bad news. 

Nonetheless, equity markets would appear to be due a correction. After a massive rally in 2019 driven by Fed rate cuts, I cannot see this being repeated in 2020. To a large extent, the rally of 2019 felt a bit like the late cycle surge of 1999 when markets were driven by irrational exuberance. With the economy in the industrialised world likely to shift down a gear, and Chinese growth at its slowest since the late-1980s, the fundamentals underpinning the markets appear less favourable. There again, equities remain the asset class of choice so unless we experience some form of major random shock, it might be too pessimistic to expect a bearish correction (in the sense of a decline of 20% or more) but upside is far more limited than a year ago. 

A second issue is climate change, which is rising up the list of things that policy makers should be paying more attention to (although in fairness, European policy makers have done more than most). The pictures splashed across our TV screens showing the extent of the bush fires in Australia are a measure of how the climate appears to be changing, and such issues are likely of be one of the key economic issues of the next decade. As long ago as 2006 the Stern Review set out the economic implications of climate change, pointing out that business as usual practices will lead to increasingly higher economic costs. The report highlighted that although the costs of climate mitigating investment are high, the costs of doing nothing are potentially even greater. When Australia’s prime minister, Scott Morrison, argues that there is no proven link between the bushfires and climate change,  it is clear that politicians have not heeded the message of the Stern Review even after 14 years. And when Donald Trump sees fit to withdraw the US from the Paris Agreement on climate change it is obvious we have a problem. Undoubtedly, we are going to hear a lot more from Greta Thunberg this year and in years to come. 

Central banks have started to make lots of noise about climate issues with Christine Lagarde suggesting it should be a “mission critical” priority for the ECB. Although climate change does not pose an immediate risk to the financial system, there are concerns that rising payouts as a result of climate-related issues could pose solvency problems for insurance companies, or that loans secured against property at risk of flooding could increase the burden of banks’ bad debts. There are those who criticise the actions of central banks’ intervention in this area, arguing that if they get involved in climate issues what is to stop them widening their remit into other areas? Whilst there is some truth in the argument, it is merely another example where central banks are providing a lead on policy issues where governments are unwilling or unable to step up to the plate. 

Above all, politics will remain one of the dominant themes of the year, indeed decade. The big event of 2020 will be the US presidential election. A few months ago I would have said that the odds were in Donald Trump’s favour as he seeks re-election. I am less sure today. A lot will depend on how impeachment proceedings go; how the rest of the world reacts to the US intervention in the Middle East and who Trump’s Democratic opponent is. One thing is highly likely, however: It will be an even nastier campaign than in 2016.

Closer to home, 2020 will be the year that the UK finally leaves the EU – almost four years after the narrow vote in favour of doing so. The Conservatives’ huge parliamentary majority should prevent a repeat of the fractious discourse that characterised 2019 but many battles lie ahead. I still maintain that the economic risks associated with Brexit outweigh any possible economic benefits (which continue to elude me) but the real cost burden will only become evident in the longer term. I suspect that as the year wears on, Boris Johnson’s government will begin to find how difficult it is to deliver the benefits he has long promised. 

One of the issues which will continue to dominate the agenda in 2020 will be that of fake news. Political discourse has blurred the boundaries between fact and fiction and this will be writ large throughout the presidential election campaign. We increasingly appear to live in a series of parallel realities, with the political dimension ever more separated from the rest of the real world. A return to evidence based policy making is not something that I expect to see this year. But without it, I fear the errors that have characterised recent years will continue to mount up. If economics stands for anything it is to aid policy decisions based on the evidence before us. Many of the political debates which invoke economic arguments, notably Brexit but also the US policy on trade, are based on a fundamental misunderstanding of the evidence. Whilst they have not yet significantly impacted on the lives of voters in Europe and the US, sooner or later there will be an economic reckoning. This may not become evident in 2020 but as they fail to deliver the promised benefits the pendulum will start to swing slowly back.

Some thoughts on the 2019 outlook

It is with some trepidation that we look ahead to 2019. There are indications that economic activity is slowing and markets are selling off as they adjust to changed circumstances, which is reason enough to be concerned. But the overriding concern is politics with Donald Trump applying his policy of unfiltered Tweeting rather than rational engagement, on issues ranging from China and North Korea to veiled threats about the position of Fed Chair Powell. Brexit continues to demonstrate why political decisions are too important to be left to politicians and the European elections in May will give voters another chance to demonstrate their support for populists who continue to undermine the rules-based system on which we depend.

Starting first with the economics, it is unlikely that we will see recessions in any of the world’s major economies this year (hard-Brexit considerations in the UK notwithstanding). Both the US and euro zone are projected to lose some momentum this year, with growth rates around 2.5% and 1.4% respectively roughly around 0.5 percentage points lower than in 2018. That is far from a bad outcome if realised, although some of the data around the turn of the year suggest that the slowdown may be a bit more abrupt than we thought a few weeks ago.

But the US cycle in particular looks long in the tooth: So long as the US does not fall into recession before July, it will surpass the 120 month upswing between March 1991 and March 2001 as the longest on record. But the strength of each successive upswing is weaker than the previous one and policy makers continue to fret about the weakness of productivity growth, which is the key driver of living standards, compared to previous cycles. Another puzzle for policymakers is the absence of inflation, and I doubt that inflationary concerns will justify monetary tightening in 2019. But I maintain my view that interest rates that were set in order to deal with economic conditions a decade ago are not appropriate for today’s environment. The Fed was right to raise rates since late-2015 which at least gives it some monetary ammunition to deploy in the event that the economy turns down – room for manoeuvre that neither the ECB nor BoE have.

Against this backdrop, why are markets so jittery? I have long maintained that a large part of the correction reflects a repricing after investors pushed asset valuations too far on the back of loose monetary policy and recovering growth prospects. In the course of the first nine months of last year, investors continued to force US equities higher despite the fact that the Fed was clearly engaged in monetary tightening, buoyed by the fact that cuts in corporate tax cuts were giving earnings a one-off boost. Reality finally began to take hold during the autumn but what surprised me was that many market commentators were surprised.

Regular readers may know that I track Robert Shiller’s 10-year trailing P/E for the S&P500 as a measure of the extent to which markets are out of line. Last month it dipped below 30 for the first time since summer 2017 (the post-1950 average is 19.4). On the basis of current data, the S&P500 would have to fall by another 10% just to return the P/E index to 25. This would put the S&P500 around 2270, representing a 23% decline from the September 2018 peak and only around 3% below the pre-Christmas flash crash low. Making stock market predictions tends to make fools of us all, but I would not be surprised to see US equities making a 10% downward correction during the course of this year. Whether we go lower depends very much on the outlook for 2020. I am not hopeful.

Politics remains the big concern for markets. Dealing with the easy one first, I do not believe that the UK will be allowed to crash out of the EU without a safety net in place so my prediction Is that there will be no no-deal Brexit (probability 80%). Note that the probability is not 100% – such has been the lack of economic rationality during the whole Brexit process that there are major tail risks and the events of December 2018 give little confidence that the UK knows precisely what it wants and, more worryingly, how to achieve it.

A more difficult question is what will happen in the US-China trade dispute. As a (usually) rational individual, I find it difficult to understand why the US would want to ratchet up the pressure. Admittedly, the trade dispute is hurting China but this week’s announcement by Apple that slowing Chinese revenues will hurt profits is an indication that the process is also beginning to impact on the US. My guess is that some of the tension will ease in 2019 once Trump is satisfied that China has taken some pain. But as one who has habitually underestimated Trump’s unwillingness to play by normal rules, I may be accused of being too sanguine. However, one prediction I will make is that impeachment proceedings will not be initiated against Trump as Democrats realise that the process will be politically counterproductive.

Europe will likely to continue grinding along in low gear. The economy has lost momentum and EMU members increasingly have to deal with domestic political issues. I would not like to offer odds on Angela Merkel remaining as German Chancellor, given that she has already announced her departure. But September will mark the halfway point of her final term in office and it might be deemed a good time to hand over the reins.

One change we know is happening for sure is that Mario Draghi will end his eight-year term as ECB President. The smart money suggests that he will be succeeded by former Bank of Finland governor, Erkki Liikanen. I have no strong opinions on the matter but I suspect whoever it is, it won’t be Bundesbank President Jens Weidmann whose stock with southern European nations is not high. Also this year, we can look forward to the announcement of who will succeed Mark Carney as BoE Governor, as he is scheduled to depart in January 2020. Whenever anyone asks me, I say the BoE need look no further than FCA Chief Executive Andrew Bailey. But given that Carney has already twice extended his tenure, who knows whether he might do so again?

We all know that there are no certainties in life. But I hope I am right about my Brexit call above all others. Because if I am wrong, my blog posts around early April might become less frequent as I am forced to forage for the food that we used to import.

Some thoughts on the 2018 outlook

One of the anniversaries you may have missed was the bicentenary of the first publication of the novel Frankenstein, which first saw the light of day on January 1 1818 when the author, Mary Shelley, was just 20 years old. As you are no doubt aware, the eponymous title referred to the scientist who created the monster which in popular culture now bears his name. A couple more economically relevant anniversaries will also fall in 2018. Assuming that the US economy does not go into reverse, May 2018 will mark the second longest US economic expansion on record, exceeding the 106 month upswing between February 1961 and December 1969. Perhaps of greater symbolic significance, September will mark the tenth anniversary of the Lehman’s bankruptcy – an event which proved to be a Frankenstein moment for the global economy.

From an economic perspective, global GDP growth this year is predicted to post its strongest rate since 2011 with the IMF forecasting a rate of 3.7%. Indeed, there are increasing signs that the global economy is beginning to match the optimism which has long been a feature of financial markets, with Europe likely to be one of the brighter spots after years of underperformance. But markets appear to be in the late stages of a cycle which will soon enter its tenth year, with concerns about the overvaluation of equities whilst in the credit world spreads remain narrow and covenant-lite issuance is on the rise.

As I noted in my previous post, it was possible to rationalise market movements in 2017 on the basis of accelerating global growth, low inflation and a lax monetary stance on the part of global central banks. But one of the features of the current market cycle is that many investors describe themselves as “reluctant bulls.” This suggests that they may decide to jump off the bandwagon in the event of an event which triggers a change in sentiment. This is not to say that I believe markets will necessarily crash, but it might pay to reduce the degree of risk exposure – perhaps by switching the top 10% of risky assets in the portfolio for something less risky. One curiosity of market moves of late is that the surge in US equities is increasingly reliant on a narrow base of stocks. Indeed, the so-called ‘FANG’ stocks (Facebook, Amazon, Netflix and Alphabet) accounted for roughly 17% of the rise in the S&P500 in 2017: If we add Apple, this figure rises to 25%. A market which is so dependent on tech stocks is clearly vulnerable to a shift in sentiment.

Monetary policy is likely to play a more important role in market thinking in 2018. Whilst the market shrugged off US rate hikes during 2017, it will probably have to contend with another 50-75 bps of monetary tightening this year. In addition, the Fed will continue to run down its balance sheet. Admittedly, an expected reduction of $300 million relative to an overall balance sheet of $4.5 trillion does not represent a huge amount of liquidity withdrawal, but to the extent that more air is being taken out of the monetary balloon than at any time in the past decade, it might point to a market which rallies at a slower pace than we witnessed in 2017. I expect that global stock markets will end the year higher than they began and I’ll stick my neck out by predicting a rise of 5-10% in the major US and European indices.

One of the interesting developments to watch in 2018 will be the course of bitcoin prices. There are numerous unknowns regarding the nature of the first digital currency to capture public imagination, notably who holds it. Despite the establishment of a bitcoin futures contract last month, this is unlikely to increase the depth and liquidity of the market so long as institutional investors remain on the sidelines. I still believe bitcoin is a bubble waiting to burst – it is after all currently trading 23% below its mid-December high (chart) – but predicting the future course of events is a mug’s game, as anyone who tried predicting its course last year discovered. I will, however, be that willing mug and predict that the price will end the year lower than where it started.

Politics in the Anglo Saxon world will continue to feel the aftershocks of the great 2016 populist revolt. US mid-term elections will be held in November where attention will focus on whether the Democrats can win back control of the House. Last month’s Alabama Senate election, in which Democrat Doug Jones pulled off a stunning win over his Republican opponent, Roy Moore, is an indication that there are limits to the electorate‘s tolerance of the nastier elements of Republican politics. Moreover, the parties of first-term presidents have in recent years tended to lose seats in the mid-terms, suggesting that there is a chance that the Democrats can mount a political comeback. Whilst I would not put money on it, it does raise a risk that 2018 might be the year in which political gridlock returns to Washington.

On this side of the Atlantic, the Brexit soap opera will continue to play out. In twelve months’ time the UK will be staring Brexit in the face, so it is imperative that progress is made with regard to setting out the terms of the subsequent relationship between the UK and EU. Nothing that we saw in 2017 gives me much hope that the UK government is up to the task. Such progress as we have seen has been dependent on the goodwill of the EU, such as accepting the Irish border fudge as a sign of genuine progress (it isn’t). There is also evidence to suggest that questions are being raised amongst voters regarding the Brexit process and whilst this will not mean that the UK government changes its position, it may be forced to soften it. Undoubtedly, this is a theme to which I will return.

Other things I have been asked about of late include whether I believe the Italian elections due in March are a big deal (no); whether there will be a war on the Korean peninsula (doubtful) and whether Donald Trump will be impeached (no). Unfortunately my clairvoyant abilities do not extend to giving definitive answers to these questions, so let us just say that I would assign a probability of less than 50% to any of them. Of course, the big question of 2018 is who will win the World Cup? I can respond with much more certainty than to any of the issues above: Not Italy.

Superforecasting 2017

Between the beginning of December and around about this time each year, we are assailed with forecasts for the year ahead. Sometimes the forecasts turn out to be right, other times they are badly wide of the mark. Years of bitter experience have taught me that making a point forecast for any economic quantity one year ahead is often an exercise in futility. But any forecast based on a reasonably well-thought out story is better than taking no view at all and trusting to luck. I was thus intrigued by the findings of the recent book by the political scientist Philip Tetlock and journalist Dan Gardner entitled “Superforecasting: The Art and Science of Prediction” (here).

Essentially, Tetlock and Gardner conclude that forecasting is a skill that can be learned although some people are better at it than others. The so-called superforecasters generally manage to outperform experts in a wide variety of fields because they adopt an eclectic approach to analysis, preferring to process information from a wide variety of sources. Tetlock assumes that forecasters can be divided into two categories – hedgehogs and foxes. Hedgehogs tend to have in-depth understanding of a small number of areas, whereas foxes believe the world is a very complex place and tend to avoid shoe-horning their ideas into a limited number of boxes. Perhaps not surprisingly, foxes make the best superforecasters.

Although they tend to be smart people, Tetlock finds that superforecasters are in no way geniuses. They tend to look at a wide range of information in making their judgements and are happy to revise their assessment if new information becomes available (in the same way as Bayesian statisticians, as I noted here). Whilst my record disqualifies me as a superforecaster, I was struck by one of the lessons which came out of the analysis, which is that they think in fine gradations. Thus, rather than offering an outcome with a probability of 60-40, a superforecaster might carefully weigh up the evidence and instead offer odds of 63-37.

This brought to mind my own deliberations in the immediate wake of the Brexit vote when I was prevailed upon to offer an unambiguous view of what would happen next, but the more I thought about the issues the less clear they seemed. I recall my assessment on 27 June was that the UK was likely to leave the EU with a probability of only 59% whereas in the wake of the Conservative Party conference in October, I raised the likelihood to 90%. As new information comes in, that figure may well change again. This highlights a view which is gaining common credence – and one which I have long been convinced by – that the central case forecast is by itself not much use unless we attach some form of weight to show the degree of conviction with which we hold to the view. Otherwise the forecast becomes a binary decision which is either going to be right or – more often – wrong, which is when forecasters open themselves up to the charge that they have no idea what they are doing.

So in the face of all these caveats, what are the key issues we should be looking out for in 2017? The biggest local risks are: (i) the UK triggers Article 50 in March without making any contingency plans in the event that discussions with the EU prove more difficult than expected; (ii) Marine Le Pen wins the French presidential election; (iii) Angela Merkel fails to win the German election.

As regards (i), I genuinely do not know how this will pan out. I am working on the assumption that the Supreme Court will uphold the High Court judgment and that parliament will be allowed a say on the triggering of Article 50 which will delay its implementation. As a result, I currently assign a probability of 45% to this outcome. On (ii), the polling evidence suggests (for what it is worth) that Ms Le Pen has no chance of winning the second round of voting, and consequently I would give this a probability of 25%. And I see no alternative to Angela Merkel continuing as German Chancellor, so this is assigned a probability of 10%. The joint subjective probability of all these outcomes occurring is just over 1% - negligible but not impossible (which is how in early 2016 I characterised the joint likelihood of the UK voting for Brexit and the US for President Trump).

On the other side of the Atlantic, I would be surprised if Donald Trump can do much damage to the US economy in 2017, although further out it is likely that greater difficulties will become evident. He is unlikely to build his wall on the Mexican border; jail Hillary Clinton; deport illegal immigrants or completely dismantle Obamacare. But I suspect markets will not get the benefit of the hoped-for fiscal stimulus and as a result I would be surprised if US equities continue rising much beyond the spring (I won’t even put a probability on this one).

We should be in no doubt (as if anyone needs reminding) that the year ahead is more plagued by uncertainty than at any time since 2009. But as I say to journalists who ask whether I expect any surprises, it is the unexpected surprises which tend to do the most damage, and since by definition they are unknowable, time has a habit of making fools of us all.