How to prepare for the unknown

published 6 January 2017

826-crystal-1200 — I see stocks doing just what they're doing now

Every January analysts line up to give their views on where markets will be sitting by the end of the year. Most of these forecasts are of absolutely no value to investors, as my colleague Andrew Van Sickle notes. For a start, they're usually wrong. Worse still, they're wrong in predictable ways mostly such forecasts merely extrapolate the immediate past into the very near future, then use that to generate a spuriously accurate figure for where the FTSE 100 might end the year, or what the ten-year US Treasury might yield on 31 December 2017. In effect, most analysts just say: "Expect more of the same."

So given that no one has a crystal ball if 2016 showed us anything, it's that even "the wisdom of crowds", whether channelled through polls or markets, is not a reliable guide to the future are any forecasts useful at all? The answer is yes but it's better to focus on ideas that seem outlandish (to you at least).

No one is an entirely passive investor. We all make asset allocation decisions, even if only to consider the split between cash and investments in our portfolios. When we do that, we can't help but be swayed by our own biases. Neither Brexit nor the victory of Donald Trump in the US election were bolts from the blue they were viewed as unlikely, but they were still clearly strong possibilities. Yet judging by the shell-shocked reaction in some quarters, many people saw these outcomes as utterly unthinkable.

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As Cullen Roche of the Pragmatic Capitalism blog puts it: "Most people want to be told the things they think they already know. Good asset management is mostly about preparing a portfolio for the things we don't already know." A forecast that merely confirms your world view might be comforting, but it won't protect your wealth against the unexpected. The value of looking instead at scenarios that you either hadn't considered, or that contradict your own views, is that it forces you to challenge your own biases.

You might believe that inflation will make a strong comeback this year, but is your portfolio diversified enough to thrive, even if it doesn't? How much trouble will you be in if things don'tpan out as you hope? As economist Tim Harford notes on his blog, "scenario thinking" is not about producing better forecasts. "What it should deliver is preparedness." With that in mind, we've looked at some of the more interesting "outlier" forecasts we've seen below.

What to expect in 2017: EU unity and a boom in magic mushrooms

Each year Saxo Bank releases its "ten outrageous predictions", and there's usually plenty of food for thought. For example, one mainstream fear this year is that political upsets could lead to a crisis in the eurozone. But what if the big surprise is European Union unity? Here's how it could happen, says Saxo: rising populism persuades EU leaders to abandon austerity, issue joint EU bonds, and launch a €1trn stimulus, "reinforcing the integration of the region and prompting capital inflows".

Or what if the bond market makes a big comeback? US ten-year Treasury yields hit 3%, causing a market panic. The Federal Reserve decides to copy the Bank of Japan, and prints unlimited sums to drag yields back to 1.5% and fix them there. "This... promptly stops the sell off in global equity and bond markets, leading to the biggest gain for bond markets in seven years."

Other interesting calls include the idea that Italian banks could be the best-performing equity asset of 2017 (when Saxo proposed this about Brazil in 2016, it seemed equally unlikely); or the idea that bitcoin will soar to $2,100 a coin as China and Russia seek alternative reserve assets to the US dollar.

Meanwhile, BreakingViews.com has some interesting ideas to watch. Following the widespread adoption of marijuana for medical uses, hallucinogenics which can alleviate anxiety and depression, recent studies suggest could be next, reports Dominic Elliott. So watch out for the commercialisation of psilocybin, the active ingredient of "magic mushrooms". And in the tech sector, this could be the year that commercial drones finally hit the big time, as regulatory guidelines issued in both China and the US last year start to bed in.

John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.