The end of the year is a good time to ask what we should always ask: what have we got right and wrong, and what can we learn from this? We must always mark our beliefs to market.
Let’s start with what I got wrong.
In macroeconomics, my main mistake was to expect wage inflation to rise in 2017. It didn’t. And because of this, the profits of smaller domestically-oriented companies were not squeezed as much as I expected.
Of course, I was not alone in making this mistake, and nor was the surprise confined to the UK: the US Federal Reserve made the same mistake I did.
This implies that the Phillips curve – the relationship between unemployment and economic activity – is flatter than I expected. This is perhaps because workers have suffered a loss of bargaining power. Because labour markets have become more atomised – not just because of a decline in trades unions – they cannot parlay low unemployment into pay rises to the extent they once did.
I’m not sure, though, that investors should take much comfort from this. We don’t know if workers have permanently lost bargaining power. Maybe there’ll come a point at which unemployment falls so low that wage growth does take off; the fact that it has risen in recent months is consistent with this.
Even if wage growth does stay low, however, it might not be good for investors. In the long run, low wage growth means low consumer spending growth: this year, workers ran down savings to sustain spending, but this cannot go on forever. This means that what companies gain from lower costs if offset by lower revenues. That’s not good for aggregate profits.
Worse still, if workers cannot advance their interests in the market place they might try to do so in the ballot box. This might turn the political climate more hostile towards equities.
A second mistake I made was to sell in May.
Yes, Halloween 2016 was a good buy signal; the All-Share index gave a total return of 7.1 per cent from then to May Day. But May Day was a lousy sell signal; total returns were 5.8 per cent in the subsequent six months.
For me personally, this foregone return was a price worth paying to avoid the chance of a big fall. As I wrote in April, however, others of you might differ.
What we should infer from this is, however, unclear. We just can’t tell whether the 'sell in May' signal has broken down, or whether this year’s decent return was just ordinary noise around a poor average.
So, what did I get right?
Market direction, for one thing. In January I said that leading indicators pointed to the All-Share rising around 9 per cent in 2017. As of this writing, it is up by 6.2 per cent, which is well within error margins.
This matters. The same lead indicators that told us that now tell us the market will fall slightly in 2018; this is mainly because the ratio of the global money stock to prices is low.
In truth, though, this isn’t as impressive as it seems. A naïve forecast would also have predicted a moderate rise in share prices this year. My leading indicators have passed the test this year, but it was an easy one.
Another thing I got right was to extol the virtues of the 10-month average rule – the rule that tells us to buy or hold when prices are above their 10-month averages and sell when prices fall below them.
This worked especially well this year for Aim and emerging markets. In both, prices began the year above their 10-month averages. And both delivered good returns. Aim has risen over 10 per cent as I write, while emerging markets have risen more than 28 per cent in US dollar terms.
Again, though, this year has been a weak test. What we really need to know is whether the benefits of following the rule – riding bubbles and avoiding the worst of prolonged bear markets – outweigh the costs, of not buying on dips. We know they have done so in the past. But 2017 adds little to our evidence.
Another success was that in February I abandoned my long-standing belief that a minute spent thinking about exchange rates is a minute wasted and forecast that sterling would bounce back. Since then, it’s risen 7 per cent against the US dollar and 9 per cent against the yen. Yes, it’s slipped against the euro. But its trade-weighted index is up. It’s so far, so good, for this call.
This matters because it’s consistent with the long-standing theory that exchange rate overshoot their fundamental value.
I’ve also been roughly right about equity strategies. I’ve believed for some time that momentum and defensive investing are two ways to beat the market – and perhaps the only two. Both have worked this year. My no-thought momentum portfolio is up by 25.6 per cent compared with the FTSE 350’s 4.7 per cent, and my low-risk portfolio is up 8.4 per cent.
The caveat here is that negative momentum did better than I expected, rising by 6.5 per cent so far this year.
Overall, then, I’ve had some failures and some successes. But as the year has been a quiet one, the signals it has sent haven’t been especially strong.
The story here, of course, is not about me. All of the above forecasts have not been my idiosyncratic opinions. Instead, they’ve arisen mostly from the economic research of cleverer people. I am merely the carrier of a tradition. The lesson of this year’s successes is that proper economic research – that which heeds the facts more than theoretical elegance – can sometimes be useful. And only sometimes, because perhaps we’ll never know enough to be able to make infallible forecasts.
Whatever methods you use, however, you must always ask: was I right or wrong, and what can I learn? Without feedback, progress is impossible
