The Market Risk That No One is Talking About

 

 

 

 

 

 

  Eran Peleg, Chief Investment Officer 

 

 

For investment professionals, the year-end holiday season comes with an additional ritual. Perhaps it is not as fun as some others, but nonetheless it is often quite fascinating. I am talking about reading the annual investment outlook reports issued by global financial institutions and asset managers.


In recent weeks, I have received and read several of the ‘2018 Investment Outlook’ strategy reports. They are all fairly optimistic about the current economic environment and what it means for growth-oriented financial assets. They mention the fact that for the first time in several years, we are experiencing synchronized global growth. This is true. They see inflation remaining fairly muted and hence monetary policy (e.g. interest rate) being tightened very gradually. In short, most of these reports see a continuation of the 2017 market environment into 2018. They also always have a section on risks. Some risks, like ‘China’, have been on the list for many years now. Geopolitics (e.g. Brexit, North Korea) is an addition of very recent years. This year, some have added to the list an additional factor -- upside risks to inflation.


What I found quite astonishing about my reading session was that it just felt like I was reading the same report over and over again… the 2018 outlooks and forecasts issued by multiple financial institutions were extremely similar.


This situation creates an additional risk for financial markets – the risk of a too-narrow consensus view. Financial market prices reflect investors’ forward-looking views, expectations. If everyone is now thinking pretty much the same, then current markets reflect a single view about the future. And what happens if future events cause this view, or elements of it, to change? When consensus breaks, the risk of a significant market swing (to the upside or downside, depending on the nature of the change) is much greater than if no strong consensus exists. Watch out.

 

Oscar Wilde, the great 19th Century poet and writer, had a clear view about consensus thinking. I will leave you with his always thought-provoking words:


“Whenever people agree with me I always feel I must be wrong.”

 

 

Happy Holidays!