2018. You ready?

I hope this is the shortest 2018 post you will read. In my battle against overthinking, I’ve tried to boil this down to bare bones. Feel free to follow up with questions.

Here are the three thoughts to which I attach the most importance for 2018. Things never turn out ex post as neatly as you lay them out ex ante, but this is my base case/point of departure for the year:

We are probably underestimating the positive effect of tax cuts on earnings. I think we have two biases holding us back. One, many of us dislike the policy and reflexively want to short anything Trump does. Two, after the fantastic run the market has been on, it is hard at some deep intuitive level to believe it can continue apace. And if we really are underestimating the effect on earnings, multiples are very likely to continue expanding as well. The US has a disproportionately large effect on global market psychology, so this would also be very positive for risk assets around the world.

Easy to imagine a shortage of assets narrative emerging this year. Moreover, it might even be true. We know it’s probably true in bonds. Might be true in equities as well. True or not, though, it would provide good cover for multiples to expand further, and could open the door to some really ludicrous valuations down the road as well.

Solid global cycle + markets tend to go up over time = It’s still too risky to position bearishly.

Yes, I know markets always top on good news, and I know it’s going to end badly sooner or later. But we also have to remind ourselves that, over time, getting caught out long in a bear is a less costly than getting left behind in a bull. If you got out 3 or 4 years ago and let valuations and macro ‘possibilities’ keep you out, you’ve been in pain. I’m not trying to mock anyone with this, just pointing out that for institutional asset managers right now not enough beta is real talk.

So, bottom line is this is the backdrop I have to run with—or at least should try to run with—until abundantly indicated otherwise. In other words: be generous with the benefit of the doubt. Especially given that this is the phase when things could easily accelerate to the upside, as if often happens later in cycles. I know it’s natural for it to feel wrong to be bullish after such a run, but you’ve got to focus on playing the odds.

And frankly I like the embedded odds that the Fed won’t make a disruptive policy error. They could, but the market in the aggregate has convinced me that it’s still clinging to too much expectation/hope of one. Also, for the first time in a long time, you can’t dismiss out of hand the risk of inflation upside, making bonds a much more balanced bet. Lastly, if/as we move out the risk cycle from here, I would expect it to continue to impart a bearish bias to the dollar.

Basically, if these points are even close to being right, that’s AYNTK.

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