When Market Predictions Fail

Coverage of the Investment Innovation Conference

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cyrstal ballAsset managers are frequently asked to give an outlook — a forecast or even a prediction. But those are meaningless without two conditions: a time frame and an expected probability.

That’s why news headlines can safely be ignored, suggests Peter Fitzgerald, global head of multi-assets, Aviva Investors in London. For example, he notes that after the famous 1979 “Death of Equities” Businessweek cover, “more recently, ‘Ready for $150 Oil?’ was on the front cover of Barron’s, and what did oil do subsequently? Well, we know it bottomed out at $28 and now it’s trading around $64. At the start of 2017, I couldn’t find a dollar bear, but the cover of the Economist is a really good contrary indicator for those people who follow the markets. What did the dollar do for the next little while? Well, it lost about 11.5%.”

He concludes that “we must always build into our portfolios scenarios that we don’t necessarily think will happen but might happen. To protect ourselves against the event, the key is to follow the data and the probabilities. If people had followed the data, these events weren’t as unlikely to happen.”

Fitzgerald believes that global inflation has reached a turning point — at least in the sense that the deflationary cycle has halted. But it’s imperative to look at what markets have priced in — not what the headlines bode.

As he says: “What the markets are telling us is that they expect the Fed to raise rates five to six times between now and 2020. So, if that seems a rather pessimistic outlook, we would take the view that those rates should probably be higher than that. For those of you who like active equities, this is a case for optimism.”

We must always build into our portfolios scenarios that we don’t necessarily think will happen but might happen. To protect ourselves against the event, the key is to follow the data and the probabilities. If people had followed the data, these events weren’t as unlikely to happen.

On the bond front, Fitzgerald adds, “Next year, because of the reduction of asset purchases, you’ll actually be moving into an environment where you’re going to have a positive supply of fixed income for the first time since 2012. What that will do to bond yields and interest rates, we will see; my guess is that when you have more supply, prices may be adversely affected.” But not every trend is potentially positive. Higher interest rates could take a bite.

“You can look at every particular point in history where the U.S. has raised rates, and somewhere there’s been an accident: the Tequila Effect; the Asian financial crisis of 1997; the tech bubble; and then the housing bubble. The theory today is that the accident is going to be in emerging markets. I would question that opinion, given that perhaps more of the risks are closer to home than farther away, particularly as emerging markets have issued more and more of their debt in local currencies rather than in dollars.”

Fitzgerald’s takeaway is three-pronged: ignore the headlines, watch hindsight bias and recognize that “perhaps the bubble is in the safe assets rather than the really risky ones.”

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