Update No. 287 – 15/01/17

The broader market continued its recent rise (third consecutive blogpost where our benchmark hit an all-time high), Unfortunately our portfolio has done next to nothing in the first couple of weeks of 2017. The swell of economic positivity of late has me given to think of the importance of psychology in economics. The tidal wave of global positivity in the second half of 2016 has continued into 2017 (so far).

Economics is the most difficult subject in the world. Seriously. There are obviously subjects that are harder to learn the basic frameworks for. There are subjects that require greater cognitive capacity due to the breadth and complexity of their subject matter. There is no subject I’m aware of however where the application of the same set of inputs in two ostensibly similar (culturally, demographically etc.) subjects can result in such widely different outcomes.

In physics, if I say that when I drop this object of this building that after x-seconds, it will reach a speed of y-metres per second, these numbers will be always and ever true (notwithstanding there are minor variations in the gravitational pull from place to place in the world, but these can be known in advance and the calculation doesn’t require post-hoc adjustments if we properly calculate the inputs prior).

This is because economics is the sum of the hopes, dreams, biases and feelings of the people. As much as we deride ourselves for our predictability, occasionally we behave in ways as a group that confound reasonable analysis.

If the median citizen believes things are going to be better in the future than they are today, at least for the foreseeable future, this self-fulfilling prophecy will be true.

At EGP, we did better than most with how we thought the Brexit situation would unfold. We thought Leave was a likelier outcome than markets were pricing (time spent talking with folk in the Northern areas that voted heavily to leave in the weeks prior to the vote helped this non-consensus view), but we also differed sharply on what would happen should the Leave vote succeed.

We were extremely confident that the economic disaster most economists were warning of if the UK voted ‘Leave’ would not come to pass. My view was that there was a large, and largely silent group of people who had felt gloomy about their situation for years, who would feel like they had effected a change which would be net positive. Even if it had next to no effect – they’d feel like they’d taken ‘decisive action’ and feel good about it.

I was confident that the £ would fall sharply, exports from the UK would rise sharply, imports would drop and there would be an uptick in inflation, which most countries had been working hard to generate. There is obviously some risk that elements of structuring the Leave package could be economically harmful to the UK, but that the implementation would take longer than anyone thought (for the very bureaucratic reasons that most people voted Leave in the first place). My instinct was that the disaffected group who had been so gloomy for years would free their wallets a little and the predicted recession would not only not happen, but growth would likely improve due mostly to improved sentiment.

The median citizen (Mr & Mrs 32.05m in the UK), would feel better about their situation and as such their situation would improve. Quarterly GDP, which had averaged only 0.4% (and trending down) in the 4 or 5 quarters per-Brexit have averaged over 0.6% since (with upward revisions). The improvement is not massive, but in the face of the median economists’ view that the UK would fall into recession by December 2016 if Leave won, it’s a truly awesome difference.

When it came to the election of Donald Trump, our view of how the world would unfold was not nearly so successful as with Brexit. The difference here again comes down to human psychology.

I had (incorrectly) estimated that in the event of the election of Donald Trump that the median citizen (Mr & Mrs 162m in the case of the US) would likely feel worse post the election of President Trump. Not because of anything he’d do, but because the media would be so overwhelmingly despondent about the election of Trump (newspaper endorsement ran 500-27 in favour of Hillary Clinton) that the feeling would somehow sway the median American.

Here I think I had underestimated just how distrustful the average citizen has become of news-media. They preponderance of ‘opinion’ posing as ‘reporting’ has eventually been noted by the median citizen.

Nothing that Trump has yet done (he doesn’t’ take power for another 5 days) has had any effect. In fact, most of the populist trade policies he intimated he would introduce would actually be harmful. Despite this, the World Bank and other global economic institutions have begun massaging 2017 expectations upward for the first time in recent memory. The change is purely one of sentiment. If people feel like the economy will improve, then like Jean Luc-Picard instructing Number One, they will:

Economics is a fascinating area for these reasons. In no other area can ‘experts’ so regularly get things so spectacularly wrong and still remain experts.

I should point out a lot of this sort of thing I find intellectually stimulating, but it doesn’t have much impact on the way I invest your money. Here, as always, I am on the lookout for excellent businesses with skilled management, operating in industries with favourable long-term trends – Tony Hansen 15/1/2017

^{*1 after a 31 May 2013 dividend of 2.333 cents per share (cps) plus 1.000 cps Franking Credit, a 31 May 2014 Dividend of 7.000 cps plus 3.000 cps Franking Credit and a 31 May 2015 Dividend of 8.6667 cps plus 3.7143 cps Franking Credit and a 31 May 2016 Dividend of 6.0000 cps plus a 2.5714 cps Franking Credit}

^{*2 calculated based on dividends reinvested}