January 18, 2017
Excerpted from a letter sent to clients on January 18, 2017
We’ve often argued that trying to invest based on economic and political current events what we call “headline investing” — is unlikely to work well. (The reasons are many; a good refresher can be found here).
2016 was a disaster for headline investing. Here are some of the more prominent examples:
June — Brexit
The “Brexit” referendum was widely expected to fail (betting markets were only pricing in a 10% chance of it passing2). The consensus view was that if the referendum did pass, it would be terrible for the global economy and markets — and sure enough, global stock markets were brutalized in the two days after the vote.
But after that, and despite widespread gloom, stocks staged a quick recovery. Within a week after the Brexit vote, global markets as a whole (and Europe in specific) were actually higher than they’d been a week before the vote, when everyone still expected Brexit to fail. Point to point, despite the intervening panic and widespread predictions of doom, Brexit ended up being a complete non-event for markets (at least so far).
November — The US Election
You’ve doubtless all heard that Hillary Clinton was widely expected to win the presidential election. What non-finance nerds might not know is that, in the immediate wake of Donald Trump’s upset victory, markets tanked: US stock futures were down 5% on election night before trading was halted to prevent further declines.3
Most pundits were patting themselves on the back at that point, because the consensus view had been that a Trump victory would be very bad for markets. Yet when the US stock market opened the next morning, the selloff never came. By the end of the day, stocks were up, and the rally has continued from there.
Summing it up: the outcome was the opposite of what was widely expected, and while the reaction to that outcome initially met expectations, that lasted for less than a day and then went in the complete opposite direction. This sequence of events perfectly illustrates the futility of trying to map political events to market outcomes.
December — The Italian Referendum
Italy’s December referendum to overhaul their constitution was less high profile here in the US, but among economic and market nerds it was viewed as a potentially huge deal. It was expected to lose by a small margin, and there was a wave of warnings about how a defeat might trigger serious market instability and possibly even the death of the Euro.
The referendum did lose, though by a crushing 20% vs. the expected 3%.4 But after a verybrief initial selloff, the Euro currency and European stock markets actually rose!
One commentator summed it up in a pretty amusing way: “After Brexit, it took three days for markets to shake it off, with Trump it took three hours, with Italy it took three minutes.”5
Sure, these developments will all have varying degrees of impact on markets and economies over time — but we don’t know in advance which way events will unfold, and even if we did know, it’s obviously impossible to consistently predict how markets will react.
Imagine an investor who was somehow able to know advance that all the following would happen in 2016: first, stock markets would start the year with a panicked decline and the worst January in history; then England would vote to leave the European Union, shocking international stock markets into double-digit losses; then Donald Trump would win the presidency in an upset victory; and then Italy would vote in a way that many thought would kill the EU. Armed with such foreknowledge, the investor might well have assumed that stock markets would not have good returns in 2016. But as we can see with the benefit of hindsight, that investor would have been wrong.
As important as certain events may seem at the time, prominence in the news cycle is not the same as importance to markets. Any given event, even a newsworthy one, is just one small part of a huge and complex ongoing series of events — so, it is crucial not to get too caught up with any given news situation of the day. We think 2016 illustrated this point very well.
This is not to say that markets will always brush off the scary headlines like they did last year. Significant downturns can and do happen from time to time; that is part of the expected path. We just don’t know what will trigger them… or when they will end. Value investors will do better to discount the headlines, invest in portfolios that align with their risk tolerance, and stay focused on value and the long-term opportunities that downturns can bring.
1 — Source: Star Capital
2 — Source: Bloomberg
3 — Source: Bloomberg
4 — Source: Oaktree Capital Management
5 — Source: Bloomberg
6 — Source: Marketwatch, to cite just one of many examples