As each year draws to its close, I like to identify the main X-factors that have affected investment markets in those 12 months — and to select the X-factor for that year. I’ve been doing it since 1982 and, if you’d like a full record of the X-factors over those 37 years, email me.
X-factors are the largely unexpected influences that come from left field — we used to say out of the woodwork — to have a serious effect on investment returns. Their key characteristic is the element of surprise. If the influence was widely predicted or anticipated, or already built into market pricing, it’s not an X-factor.
The X-factor in investment markets can be negative for investors (recall the near meltdown in global banking in 2008, the terrorist attacks in the US in 2001 and the sharp rise in bond yields in the fake crisis of 1994). Or it can be positive (think back to 1991, when our trend rate of inflation fell markedly, or to 1998 and 2008 when the Australian economy coped so well with, respectively, the Asian crises and the global financial crisis). Or it can be both positive and negative for investors (for example, the election of Donald Trump as US president in 2016).
An obsession with the X-factor does not preclude our taking a view on prospects for the economy, shares, interest rates and property. Instead, it’s a reminder that investors must always allow for, and cope with, the many uncertainties and surprises that affect investment returns. Investors always need to maintain an appropriate diversification (including holding a core holding of safe assets even when yields on them are negligible).
In 2017, my X-factor was the better-than-expected news on the global economy — the rare combination of quickening growth, negligible inflation and accommodative monetary policy that supported unusually high prices for shares and bonds, and kept volatility to record lows. Those were exceptionally good times for investors … while they lasted.
There are lots of contenders for the X-factor of 2018. They include, in no particular order:
● The whole of the US yield curve for government bonds has moved significantly above the Australian yield curve;
● Our ditching a fourth prime minister in eight years;
● The huge impact of the royal commission into banking and financial services, even before the release of the final report;
● Escalating trade wars;
● The continuation and speeding up of the US economic upswing that began in 2009;
● In many countries, including the US and Australia, modest inflation despite strong growth in jobs;
● The increase of 25 per cent in US corporate profits in the 12 months to mid-2017, thanks mainly to the US tax cuts;
● Brexit;
● The failure of Bitcoin (and its look-alikes) to provide investors with the stable or predictable store of value that its promoters claimed;
● The nasty wobbles in share markets in February and in recent weeks;
● Trump’s much-criticised decision-making and governing;
● In China, just a mild slowing in growth allowing our bulk commodity prices to hold up well; nonetheless, Chinese share prices falling sharply;
● Investors’ increasing realisation that the Fed is serious about normalising US monetary policy;
● The widening spread, here and abroad, between the official cash rate and bank funding costs;
● Intense concerns of an imminent crash in housing prices, despite the orderly decline, to date, in the median house price; and
● Our household saving ratio falling to zero.
In my view, the X-factor this year is the huge impact of the royal commission into banking and financial services.
It’s a damning report, exposing many failures, misconduct and bad advice on the part of financial service providers and advisers.
Already, the operations and governance of financial institutions have been tightened and further comprehensive changes, including in regulation and the reporting on financial services, are to be made over coming years.
Next year will also have its X-factor. As always, trying to identify the X-factor for the next 12 months is a futile exercise: if it’s been predicted, it’s not the X-factor.
Don Stammer is an adviser to Altius Asset Management and Stanford Brown Financial Advisers. The views expressed are his alone.