A December 21st report from Source Research offers some thoughts on the biggest economic surprises of 2014, including a discussion of probable, possible and totally unpredictable events.Source analysts Paul Jackson and András Vig discuss the importance of prediction in investing, and exhort investors to consider their biases when making predictions about the likelihood or unlikelihood of events.
They note: “We can’t do anything about the total surprises but we can think more carefully about the probabilities we assign to seemingly unlikely events. The quiet period over the holidays could be a good time to revisit our assumptions.”
Biggest Surprises of 2014 – Predictable “surprises”
One point Jackson and Vig emphasize in their report is that some “surprises” are really quite predictable. This, of course, in many cases sets up for an excellent investment opportunity. Of course, “predictable surprises” don’t always come to be or they wouldn’t be surprising at all.
They say that many of the events of 2014 were “foreseeable and widely predicted”, including the U.S. Fed taper and the resultant strength in the dollar; the strong performance of peripheral bond markets in the Eurozone; the election of Modi in India and related outperformance of Indian assets; Scotland remaining a part of the UK and most commodities continuing to weaken.
Biggest Surprises of 2014 – The thorny problem of consensus
The authors of the Source report also highlight that the best strategy for making money in investments is to be out of consensus. They point out that if you are right the payoffs are big, but if you are wrong the pain is generally limited. The other side of the coin is that following correct consensus views typically offers minimal upside, and incorrect consensus views can be very expensive. This means the real problem at hand is determining what is consensus and what is not.
The real surprises of 2014
In their report, Jackson and Vig offer a list of what they consider to be “real surprises” in 2014, ie, events that were definitely not general consensus.
1. Government bonds yields remaining so close to those of equities in many markets, particularly given bond yields began the year so low.
2. The significant and ongoing decline in U.S .10 year bond yields from 3.0% in January to 2.2% in mid-December.
3. The fact that Greece, Ireland and Spain are among Eurozone economies outgrowing Germany in the second half of the year.
4. The midboggling decline of Spanish bond yields to under those of the U.S. and the UK.
5. U.S. equities continuing to outperform those of Europe and Japan.
6.Given the strengthening dollar, the top three equity, bond and forex markets would all be in emerging countries (excepting Portuguese bonds).
7. Saudi Arabia’s willingness to let the crude oil price drop by almost 50% in less than six months.