We need twelve months of normality, says Michael Wilson. But will we get it? Chance would be a fine thing

Is it only me who’d like to see the word ‘disruptive’ deleted from the dictionary, just for one short year?

Okay, now the New Year is with us, here’s the deal for 2018. We’ll put up with the Oxford English Dictionary giving us post-truth and selfie and vape, and maybe even covfefe, and in return we’ll enjoy a blissful twelve month break from the accursed D word. Quite frankly, it’s beginning to scare me a bit.

Yes, I know that January is a time for out with the old and in with the new. And yes, “creative destruction” is a wonderful, vibrant thing as long as it doesn’t slip its leash and run completely riot in the park and bite everybody. But it’s not just Uber and Tesla and P2P and the challenger banks that I’m talking about here. It’s the kind of disruptive that seems to have flourished around the two most toxic topics in the papers, Trump and Brexit.

What with Breitbart and 4Chan and fake news and covert election-influencing; what with midnight Twittering and £350 million a week for the National Health Service; what with Kim Jong Un and Mr Trump’s “modern presidential” style, we seem to be witnessing a sea change in the entire public edifice of truth and trust on which our civilisation is based.

Normalising the post-truth world

What bothers me especially about that is that the public is beginning to accept all this stuff as normal. So who cares if Donald Trump or Boris Johnson or Vladimir Putin say things they don’t mean, people are starting to say? These are good strong figures who are leading the world boldly into the future, albeit erratically, and they’re sweeping away all the namby-pamby ideological clutter that liberal democracy has lumbered us with.

Nor is the disruptive reality limited just to the politicos. Quantitative easing and negative bond yields and the VIX volatility index and crypto-currencies such as bitcoin are all instances of the new market truths that might very well be real and important – but which also have the potential to become abusive if we don’t keep a tight grip on them. If we ever feel that politicians’ stock is generally suffering from all this bombardment, we should be careful not to absolve the financial markets from blame for some downright manipulative behaviour as well.

I mean, quantitative easing is a very useful one-off shot to have in your locker when demand is low and volatility is high, but have you ever sat down and wondered who pays for the extra liquidity in the end? Does it get painlessly distributed through all levels of society, as some would have us believe, or is it a debt to our grandchildren? There are those who say that this disruptive stuff has the power to start an inter-generational war. Jeremy Corbyn probably wouldn’t disagree.

Okay, I’ll get off my pedestal in a moment, because we have a lot of ground to cover and time is running short. Oh for the blissful days and the green remembered hills where the only disruptive model we needed to worry about was Naomi Campbell.

So, without further ado, let’s take a look into the crystal ball and see where this complicated scenario is likely to take us.

Elections

With one minor exception, or maybe two, 2018 is probably not going to be the electoral terror that 2017 once promised to be. Apart from bitterly-fought presidential showdowns in Mexico (July 2018), Brazil (October) and Venezuela (autumn), the political battlefields of the Americas are going to be dominated by the 6^th November mid-term Senate elections – of which more anon, obviously.

Pakistan is due to hold a tense presidential and general election by 3^rd September at the latest, and Zimbabwe will presumably be voting in a new administration as soon as the country’s military guardians are feeling confident enough to allow a poll. There will be general elections in Thailand (November), Malaysia (no date set), a presidential election in Egypt (February to May), and a parliamentary election in Afghanistan (July).

Clearly, any of these could provoke trouble, but they don’t appear to be the kinds of top-grade risk events that we’ve seen in recent years. China and Hong Kong have no elections coming up, although Taiwan has a local election coming up (no date), during which the often fraught differences between nationalists and unificationists can be expected to dictate the discourse. Nothing new there, then.

And whereas continental Europe has faced (and survived) a series of nasty 2017 elections which threatened to bring nationalism and anti-Europeanism to the fore – and whereas, on the whole, it succeeded in voting them down in France, Germany, Italy, the Netherlands and elsewhere – there are relatively few major polls coming up in the new year. Unless Germany’s stalemate continues, obviously?

Perhaps the toughest to call will be in the Czech Republic, where the incumbent centre-left Miloš Zeman, a former Prime Minister, is due to face the polls in January against some worries about his health; and in Hungary, where the April poll will pit the incumbent Viktor Orban and his eurosceptic and anti-immigrant Fidesz party against sentiment from the even-further right. Zeman in Prague is also a migrant-refuser who was among the first leaders in Europe to welcome the election of Donald Trump in the United States. That’s somebody who Brussels will be watching closely, then.

Top Trumps (continued)

The surprising thing next year will be if the king disrupter, President Donald Trump, alters his erratic behaviour at all. The ten months since his inauguration in January have confirmed that the blustering, overbearing, bullying and name-calling Republican Party candidate of 2016 has become the blustering, overbearing, bullying and name-calling president we should have expected all along. As to whether the Prez’s character will move the financial markets in 2018, that’s quite another matter. Trump’s front-line political bodyguard squad, consisting of generals John Kelly, James Mattis and Herbert McMaster and former oil boss Rex Tillerson, are likely to continue doing a good job protecting the President until the day he fires them…

Oddly, however, Mr Trump’s America has proved to be a good deal more resilient than expected during 2017. Production is doing fine, and unemployment is low (although US jobless figures are always deceptive because they exclude many millions who have simply abandoned the search for work). There’s room for speculation as to how much of this he owes to the Obama legacy (which also saw a soaring stock market), and how much to the promise of the tax cuts programme which had finally completed its painful way through the Senate as we went to press.

On the face of it, Trump is proposing to give away a vast and apparently unaffordable net sum, and some of that money will go to middle income Americans and to the wealthy; the main beneficiaries, however, are businesses which will pay a lower top corporate tax rate. At least, that’s what they think – in practice, a large chunk of new taxes will come in from the likes of Apple, Facebook and Starbucks who have ingeniously offshored their earnings until now, but who the new rules will force to repatriate it.

In some ways it’s quite hard not to like that idea, but Mr Trump needs to force the tax plan through first. And at present, his stumbling chances of succeeding in the one and only policy success of his presidency so far depends on the Republicans’ willingness to concede that Trump’s tax policy is their best hope of keeping their seats in next November’s mid-term elections.

And that’s going to be the crunch in 2018. The tax plan is what’s attracting foreign money into America; but will it run away again if it fails? Trump’s scheme has weakened the dollar, which in turn has helped with the trade deficit, but the threat of trade wars with China, Mexico, Canada and Europe may yet cast a shadow over 2018 which would show us how self-sufficient America’s ebullient economy really is.

It’s a bit of an all-or-nothing strategy. Can the economy live up to the President’s own bluster during 2018? Or will Trump’s scheme be ruined by his own thick-skinned swagger, or by his willingness to insult foreigners of every kind? If it comes unwound, there’s a danger that it could unravel quite quickly. Here’s hoping not.

There, and I haven’t mentioned the Russia inquiry even once, have I?

The B word

Over on this side of the Pond, Prime Minister Theresa May is facing a different kind of disruptive threat. Having personally committed Britain to leaving the EU by March 2019 (by activating Article 50 last March), the PM has defined her role in the history books, for better or worse. Irrevocably, too, unless something gives way, either on her own side or else in Brussels.

As 2017 draws to a close, it is becoming retrospectively apparent that the rosy economic statistics that followed the June 2016 referendum vote were a flash in the pan; by this autumn consumer demand was down, growth was down, inflation was rising, and so was personal debt. (Consumers, it seemed, had financed a brief spell of splurging with new credit, and were showing signs of slowing.) Moodys had downgraded the country’s credit rating, and Chancellor Philip Hammond had come under pressure to abandon the fiscal goal of balancing the budget by 2010.

It would hardly be wise to try and second-guess what the EU27 will do during 2018, but it would be equally unwise to suppose that they are anything but exasperated with our expectation that they’ll devote very much more time to negotiating with us. That in turn is likely to come back and bite the PM quite hard – can she maintain control of the hard-line Brexiteers in her own Cabinet?

As December approaches, it’s not at all clear that Mrs May’s stumbling command can hold out. Her weary expression and the slight nervous yodel in her voice are telling us more about the strains of office than her brave talk of strength and stability. And all the time, business leaders are imploring her to make better progress with securing the transitional arrangements after March 2019. Nobody is looking forward to jumping off a cliff without even a parachute, let alone a compass.

Will all this impact on the British economy? Unless sterling plummets far enough to lift our exports substantially, it seems highly likely. By the time you read this you’ll know what was in the 22^nd November Budget (see pages XX-XX), and hopefully the path will have become clearer. What business is very clear about, however, is that Jeremy Corbyn would be only too happy to lead a socialist revolution in Britain if she fails.

Interest rates going up

If there’s one thing we can predict with confidence, it’s that interest rates are on the rise. In Britain and in America, central banks have already begun a cautious series of increases which they expect to continue during the new year. But it’s a delicate task requiring careful balancing. Too slow, and you weaken your currency and drive investment abroad. Too fast, and you choke off the recovery before it’s properly under way. And if you’re doing it to control inflation, you need to be very sure whether those rising prices represent excess demand, or whether it’s just that externally-dictated prices for oil or foodstuffs have gone up for reasons that have nothing to do with your national economy.

A hospital specialist once explained to me that, when you get a patient brought in with extreme hypothermia, you don’t heat him up as fast as possible, because that will just drop his blood pressure and you’ll have a nice warm corpse on your hands before you know it. Instead, you warm him by a degree or so every six hours, which will get you where you want to be. That’s why it would be surprising if rates rose by more than half a percentage point during 2018.

But even that would be enough to sharpen the economic divide between the young (who borrow, through mortgages and student loans) and the old (who lend). More fuel for a disaffected youth demographic! Will the Prime Minister’s worries never end?

Actually there are far more serious causes for concern. If interest rates go up, either in Britain, in Europe or in the United States, then so will government bond yields, and that will impact on bond prices in a way that is virtually certain to send the Great Rotation back into equities – a place where valuations are already too high for some analysts’ comfort. It’s a wall of worry.

The dreaded omnibubble

But let’s take a look at those equity valuations, because there are those who say that today’s apparently inflated ratios are not as high as they seem. Even the Financial Times’s highly-respected (and cautious) Martin Wolf wrote recently that perhaps this time it really was different.

Pause for effect. We are used to the old wisdom that when the shoe-shine boy at your hotel tells you to buy stocks, then it’s time to sell. But an eminence grise like Mr Wolf? Really?

Wolf doesn’t disagree that much of the investment universe is in bubble territory, and he says he’s uncomfortable that assets are moving in lock-step. (An “omnibubble”, as he calls it.) But when we observe that the cyclically-adjusted Shiller ten year ratio for the S&P 500 is at its second-highest ever level (higher than 1929 but still well below 1997-2001), are we clear about what we’re looking at?

Wolf’s argument revolves around inverting the Shiller ratio to obtain a cyclically-adjusted earnings yield which allows us to measure prospective real returns. And on that measure, he says, the current US ratio is 3.4%, which doesn’t sound so bad.

It sounds even better when you consider that CAPE estimates for Germany and the UK roll out at cyclically-adjusted real earnings yields of 5.1% and 6.2% respectively. While Japan scores a historically high-ish 4.1% yield. (Japan was never a place for particularly high earnings yields.) Wolf’s conclusion is that the US is the only major market where CAPE ratios are badly out of step with the long-term trends: those of other major markets are still well within bounds.

Then again, there are those who say that any ten-year comparison of stock ratios, such as the CAPE, is bound to be illusory because the current numbers still include the terrible collapse of 2007/2008. Once those figures have rolled out of the calculation – presumably during mid-2018? – the whole picture should look more rosy. Not necessarily wonderful, you understand, but a bit less overcooked.

What’s still hot for 2018?

So if developed market stocks are close to a peak in 2018 and fixed interest is looking profoundly overdue for a correction, what’s there left to be positive about?

Many analysts are agreed that probably the most promising area for investment at the moment lies in the emerging market area, where economic growth is still bucketing along at an impressive rate and where China, in particular, looks set to enhance its lead. Now, admittedly, some of that is happening because President Xi is taking advantage of President Trump’s willingness to withdraw from global political leadership – and to that extent, the whole picture is subject to political influence.

South America is seeing some of the regrowth that has been awaited for most of the last stalled decade – which is one reason why the 2018 polls in Mexico, Brazil, Venezuela and Colombia are all worth watching. So is the political situation in India, where growth has stalled under the initially promising leadership of Prime Minister Narendra Modi. Can he get the motor of growth restarted in 2018? It’s a good question.

We could speculate that an incipient conflict between Iran and Saudi Arabia will reignite the oil supply question, but first we’d need to accept that global over-supply of oil is quite severe and that a lot of tankers are laid up around the world. But for all that, the commodities sector appears to be moving out of its cyclical slumber these days, and if there’s one thing we can be sure of, it’s that the plant is not making minerals the way it used to.

Will 2018 be the year when synthetic ETFs finally give way to physical funds? I’ll leave that question floating, if you don’t mind. All I’ll say is that consumers are showing a distinct preference these days for physically-backed funds, which I personally take as a welcome sign that the issues of counterparty risk and the hyperbolic nature of derivative structures is becoming more widely understood. Heaven forbid that 2018 should provide us with any more reminders of the advantages of physical possession. Still, the management costs are lower, I suppose?

As for the planet….

Well, as far as we know we aren’t going to be wiped out by any passing asteroids. Unlike last September, when asteroid Bennu missed the earth by a million miles or so (quite a close shave in the bigger picture of things), there are no major cosmic calamity collisions forecast for 2018 – although a tiny 15 metre rock did pass between the moon and the earth in October (oops), and although NASA is keeping close tabs on a number of other asteroids, just for safety’s sake.

That’s not to say that errant rocks can’t cause problems. A recent uptrend in seismic activity – both volcanoes and earthquakes – has been getting the scientists worried. Recent well-publicised quakes in California, Iran, South Korea and Italy have been seen as an indication that global seismic activity may be ‘waking up’ after a period of relative quiescence. And Mount Agung in Indonesia was reported at the time of writing to be brewing up for an eruption which had forced a general evacuation. There are also reports of new (or rather, renewed) volcanic activity in Iceland.

Where’s next? We have absolutely no idea, but quakes and tsunamis are by far the bigger worry because of their ability to swamp heavily populated areas. But can we plan for these events if we think we’re entering a cycle of activity? Only insofar as we can calculate the mean times between events and then listen for warnings in the ground.

They won’t help to protect New York or Florida or San Francisco (or Tokyo) if the Big One ever hits, but that’s a threat that the financial world has had to live with for long enough now. The last really major quake, in Tokyo in 1988, had a surprisingly brief impact which was quickly absorbed – thanks, not least, to the heavily internationalised market structure which has proved itself able to carry on regardless even when major trading centres have been knocked out.

Hurricane force

That’s about as far as the good news goes, however. 2017’s devastating sweep of hurricanes, particularly in the Caribbean and central America, is being seen in some quarters as a portent of things to come. Not least, because of the inescapable evidence that sea temperatures are rising both in the Gulf and in the Pacific and Indian oceans.

We could argue the toss about whether or not these rising temperatures are the result of man-made interference, or whether (as per President Trump) it’s just the earth telling us that it’s going into a cyclical warming phase. The one thing we know about rising sea temps, however, is that they cause hurricanes.

And hurricanes, as you’ll know, have just smashed Bermuda and the Caymans and Barbuda and Saint Martin (“95% destroyed”), and Costa Rica and the British Virgin Islands where Richard Branson’s pad was levelled. There are valid questions to be answered as to what we’ll do if the storms return often enough to make these islands effectively uninhabitable in the future. But those questions are not being aired sufficiently, if at all.

And some of these bashed islands, remember, are the preferred tax havens of much of the western world. Are we asking those questions as well? I’m expecting to see the topic surfacing during the new year. Aren’t you?

As always, there are significant economic issues for advisers and planners to consider when making asset allocation decisions for 2018, and we’ve touched on many of them here. The wall of worry is there but providing clients with insight, guidance and peace of mind from knowing that their investment portfolios are properly diversified in order to weather whatever the world decides to throw at us, means that the role of professional advice has never been more important. Wishing all our readers a happy New Year, whatever it might bring!