The Year of Maggie and St Francis

Blondemoney fondly remembers the footage of (her heroine) Margaret Thatcher’s ascenscion to the steps of no.10 Downing Street in 1979. She quoted St Francis of Assisi, whose prayer notes (among many other things):

‘That where there is discord, I may bring harmony.
That where there is error, I may bring truth.
That where there is doubt, I may bring faith.
That where there is despair, I may bring hope.’

Now, before alienating anyone’s faith/atheism/pan-theism, please note that this quotation is designed to flag up how the year ahead is likely to proceed.

1. Discord -> Harmony: Volatility of volatility is about to explode

Yes, those flash crashes that we have been having for the past few years are soon going to look like a walk in the park. We have already had some warnings: The stunning near 12% decline in GBP in the 24 hours after the Brexit vote; the equally stunning 5% rally in the US Dollar in the week after Trump’s victory. These were actual trends, not some flash-in-the-pan, zero liquidity, algo-black-box mangling of the markets. We have seen plenty of those too, of course, and they are the ongoing canaries in the coalmine. A reminder that what we think of as the most liquid, will not always turn out to be so. But it is the vol of vol that we have to be so careful about. One minute, a rapid increase in greed, with all the risk-seeking indicators flashing green; the next, a period of relative calm; and then finally, a vomitous plunge into the depths of despair. But we could flip between these three states with ever increasing frequency. Discord and harmony will both be with us, all the time. It’s no wonder that even with the volatility we have had, general vol measures still look fairly well behaved – with a few spikes, but the general level still near those doldrums of 2014:

cross-asset-vol-10-year-view

2. Error -> Truth: Politics will drive everything

The reason for the flip-flopping in volatility? Well that will be the market adjusting to political risk. This has been on the agenda ever since policy makers became so deeply embedded in the prices in financial markets post-Lehman. But the shift this year is that it’s politicians and fiscal policy that will now replace monetary policy as the driver. The central bankers were the key policy makers after their unprecedented interventions of unconventional policy. But their time is over. Monetary Policy is dead. Now it’s over to the actual politicians – just as the electorate has decided it’s had enough of The Establishment. However you want to call the new populist, post-truth world, the fact is that it was a vote against the establishment that brought us Brexit, Syriza, the end of Renzi, and now Trump. This year we get the chance to see if Le Pen, AfD, and the rest follow in their tracks. For all those who think the market has now woken up to political risk, let’s think about how we are going to know if it has. We don’t believe polls any more, do we? We don’t believe that political risk is “priced in”, because we don’t actually know in what asset price that would show up, do we? Mexican peso options were pricing a 5% move on US election night: it actually moved 10%. This means that asset prices will move in a much less linear fashion: there will be steps up and steps down as reality sets in. The truth will out.

3. Doubt -> Faith: Feelings versus Facts

Trump isn’t actually crazy. Putin doesn’t actually want a third world war. Nor does the Middle East. But everyone is jostling for position in the new world order, and doubt will creep in over what our leaders actually do want. The biggest difficulty that the market will have is how to interpret Trump. Note that already he is “The New Reagan”. What a sigh of relief accompanied that assertion, huh! Markets like to have a pattern for the future – a set of probabilities to trade off. But the thing is, Trump is Trump (much as Brexit means Brexit). He’s new. He has Twitter (and he’s not afraid to use it). He’s already wiped billions off defense shares with 140 characters. He will do anything to pressure the other guy; to get deals done. Remember how millionaire engineer and UK businessman James Dyson once wanted the UK vehemently to join the Euro, but last year became a vocal Brexiteer? Businessmen don’t do politics (or indeed God, as Alastair Campbell once famously remarked). They do deals. So keep the faith. They’re not demagogues creating a new Reich; their populism is one that keeps them powerful enough to keep power. That means making a profit.

4. Despair -> Hope: Structural trends persist – inflation is back; global trade is down; but the world isn’t ending. 

In the midst of all of this, you might feel quite concerned. As those pilots trapped in a crashing plane in the Second World War noted, “this is unfortunate. this is the end”. Well both of those pilots survived, and you will too. Reasons to be hopeful?

* If every electorate voices the same anger, then whatever happens in the elections of France/Germany/Netherlands/Italy, it will be a uniting force. It will even unite those administrations with those of the UK, even as it departs the EU. The negotiating sides may find they have more common goals than they think

* Yes global trade is slowing, and may slow further – but that should mean that domestic economies grow in order to find a home for the spare demand; it should drive innovation.

* Commodity prices will rise, as a global trade war might see tariffs slapped on various goods. Surely, after several years of panicking about deflation, we can see the upside in some inflation? (Or will the irony be that following bad deflation we now get some bad inflation…?)

* Sclerotic supranational organisations will wither, doomed as irrelevant institutions for another time: and new ones can then spring up in their place. Schumpeterian destruction can apply to politics as well as economics.

* Populism can’t, and won’t, last. Beware getting what you want. It’s much better, as the Rolling Stones noted, to get what you need.

Happy 2017 everyone! The next post will explain how to express all of this via your portfolio…

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