Did anybody anywhere in the world put an accumulator bet on the UK voting to leave the European Union, Donald Trump winning the US presidential election and Leicester City winning the Premier League? The bookmakers believe not and you’d think they might have noticed – after all, these events were considered so unlikely that just a £1 bet placed at the start of 2016 on all three occurring would have netted £3,000,000.
At this end of the year, of course, while those who foresaw Leicester City as Premiership champions remain thin on the ground, there is no shortage of commentators who will tell you they predicted Brexit or Trump or both. And yet, here’s an interesting question – even if you had known the result of the EU referendum and the US election in advance and with absolute certainty, what good would it have done you as an investor?
No, nipping down the bookies is not an option in this game – we said ‘as an investor’. And at the start of the year, if someone had told you the biggest smiles on the mornings of 24 June and 9 November would belong to Nigel Farage and Donald Trump, the only equities you might have even thought about buying were manufacturers of tinned goods and shotguns. And maybe a property company leasing remote caves in Wales.
What you are highly unlikely to have done, we would suggest, is to have piled 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.
As we have observed on numerous occasions this year – in articles such as Poll position and Brexit’s double illustration – macroeconomic forecasting with any degree of accuracy and consistency is very difficult.But for our first investment lesson to take from 2016 we will go one step further:
1. 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.
The US president-elect also features in our second lesson because, say what you like about Trump, he has been great for value investors, right? Wrong. Here on The Value Perspective, we know what you are thinking – Trump has said he is going to spend money on infrastructure, which means borrowing a lot, which means bond yields go up, which leads to inflation, which for a variety of reasons tends to be good news for value (find out why here).
So at least runs the narrative – and so inevitably run a slew of media headlines – and there is only one little problem. The narrative does not fit the facts. If you look at the numbers, you will see that value started outperforming in February – months before Trump was even confirmed as the Republican Party’s nominee, let alone as president.
The Trump explanation for value doing well is an example of ‘narrative fallacy’, which can also translate as ‘people like a bit of story’. The reality, however, is much more prosaic – value investing and value investments had underperformed for so long and become so cheap that their discount to momentum had grown too great for the wider market to ignore.
People may like to be able to point to a catalyst for something happening but that does not mean one exists. Even with 10 months of hindsight, we are unable to pick out a particular number on a particular day and say, there, that is why value started to outperform – and the same is true for any number of big market turning points. Lesson two then is:
2. Don’t look for catalysts and ignore any narrative – just focus on the numbers.
In addition to unpredictable events and value’s resurgence, a third big investment theme of 2016 has been the market’s obsession with supposedly ‘safe’ and ‘stable’ equities. As we have noted this year, in articles such as No defence, this has seen the prices of large companies with historically low volatility – the so-called ‘bond proxies’ – bid up to what would appear distinctly unsafe and unstable levels.
And that is rather the point. In investment, there are no equities that are always safe or always risky – only equities that are too cheap or too expensive. So a business could have the most volatile earnings stream in the world but, if you buy it at a 90% discount to fair value, you are giving yourself a very good chance of making money from the investment.
In the same way, you could identify the business that boasts the most stable earnings stream in history and yet, if you pay 10 times what it is worth, you are highly unlikely to make money – indeed, you are more likely to end up losing money. To us, that is the definition of risk and it has nothing to do with the supposed predictability and stability of an asset – only the price you pay for it.
And so what was widely perceived to be safe this summer – for example, tobacco businesses, beverage companies, utilities and real estate investment trusts – have generally seen their share prices fall in absolute terms, while the supposedly risky banks, retailers and more cyclical businesses have broadly seen their share prices increase in absolute terms over the same period.
So our third and final lesson of 2016 is:
3. Safety stems from the price you pay, not the underlying dynamics of the businesses you buy.
We hope visitors to The Value Perspective will find all three instructive although history suggests the wider market may well have forgotten them by this time next year.