5 Lessons Investors Can Learn from 2016

Few would have predicted that in a year where the UK voted to leave the EU and the US elected a reality TV star as president, equity markets would be higher

Cherry Reynard 30 December, 2016 | 3:07PM
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2016 held some considerable surprises, not just unexpected political events, but financial markets’ response to them. Few would have predicted that in a year where the UK voted to leave the European Union, and the US elected a reality TV star as president, equity markets would be higher. What lessons can be drawn from the events of 2016?

1. Macroeconomics influence markets in the short-term, but are inherently unpredictable

Macroeconomics has undoubtedly influenced markets in 2016. There was the post-Brexit rally in large cap equities, and the ‘reflation’ trade in the wake of the US election result. Also, Brexit will have a real influence on some companies who trade with Europe, so cannot be ignored.

However, investors should not over-estimate the role of macroeconomics on markets, which – for the most part – have carried on regardless, supported by a global economy quietly chugging along behind the scenes.

Kevin Murphy, a fund manager on the equity value team at Schroders says in a recent blog: “Macroeconomic forecasting is not only very difficult, it frequently doesn’t help, as the market may move totally contrary to what you believe is appropriate.”

He points out that even if investors had predicted the victory for Trump and the vote for Brexit, they were extremely unlikely to have moved into equities across the board, “on the basis the market would take just a couple of weeks to bounce back from its post-referendum losses, and not even a day to account for Trump’s impending residency in the White House, before resuming its march towards all-time highs.”

In other words, even if an investor had forecast correctly, they probably wouldn’t have forecast the consequences. With that in mind, investors should consider lesson two.

2. Stay invested

Plenty of financial advisers had to resist demands from their clients to move all their assets out of the stock market ahead of the Brexit vote.

Will Hobbs, head of investment strategy in UK & Europe, Barclays Wealth and Investment Management, says: “Investors are usually better off tuning out the multitude of talking heads and making sure they are fully invested in a range of assets – the details of the future, good and bad, will always elude us, but over time optimism, and being invested, have tended to be rewarded.”

3. The true meaning of probability

The polls were actually reasonably accurate in the run-up to the Brexit vote, having learned their lessons from the UK General Election. On the June 13, the Financial Times Poll of Polls gave the ‘leave’ camp a small lead – 46% versus 44% for remain. Even in the US, the pollsters were within the 2-3% margin of error they usually quote. The betting odds – so successful at predicting the result of the election – fared less well.

The problem was with the interpretation of the results. Too often, the market took equated a 20% probability with zero chance. In the run-up to the Brexit vote, markets were highly selective in the polls they chose to believe, sending the UK stock market and currency higher. Either way, betting one way on a binary outcome proved a poor strategy.

4. The true meaning of risk

The last few months of 2016 may be the beginning of the end for the 30-year bull market in bonds. Gary Potter, co-head of the multi-manager team at BMO Asset Management, formerly F&C, points out how unprepared many are for this change: “A low risk portfolio a year ago may have had around 60-70% in fixed income. Over that period the gilt yield has been as high as 2% and as low as 0.5% and that asset allocation has remained broadly the same. A lower risk portfolio is in the eye of the beholder and the real risk is capital loss.”

He also points out that some of the areas that might be considered more defensive have also performed poorly in 2016. Absolute return funds are, on average, barely in positive territory for the year, while commercial property funds have taken a Brexit-related hit. The ‘quality growth’ companies that had become so expensive as investors sought safety at any price started to sell off towards the end of the year.

As Murphy at Schroders concludes, “Safety stems from the price you pay, not the underlying dynamics of the businesses you buy.”

5. Monetary policy has its limits

The ‘Paradox of Thrift’ is a phrase popularised by economist John Maynard Keynes to describe a situation in which individuals become insensitive to interest rates. They continue to try and save during periods of economic weakness because they don’t feel confident enough to borrow, however cheaply. This renders monetary policy less effective because demand for credit decouples from the level of interest rates.

This was seen this year. It became clear this year that most of the people and companies who felt willing and able to borrow had done so. Equally, negative interest rates had unintended consequences, actually leading to higher mortgage rates in some cases. This is likely to see, if not the end, then at least the slowing of the great monetary policy experiment seen since the Global Financial Crisis.

Of all the lessons of 2016, there is perhaps one that is the most important.

Nick Sheridan, European equities manager at Henderson concludes: “Broadly speaking we would always advocate stopping to think before acting. This has been particularly important this year with markets often driven by sentiment, rather than logic or data.” 

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Cherry Reynard

Cherry Reynard  is a financial journalist writing for Morningstar.co.uk.

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