The brutal fact is, being a fund manager means making predictions and predicting is hard, especially in financial markets. Not only do you need to predict which companies will prosper or wither, but also how other investor views on these companies will change. You need to get both parts right to win. There is no short cut.
In the world of relentless prediction and error it is easy to get lost and confused. But you must never stop predicting. Stale predictions are dangerous; they encourage lethargy or belligerent denial.
When we look back at 2018, the market made several mistakes - the framing of ‘Rational Trump' and misunderstanding China's growth.
Trump is behaving like a classic ‘boss'
The biggest mistake by far last year was the belief of what drives Donald Trump and what it means for growth. In our view, it was widely assumed Trump was unpredictable and irrational, but whatever he did would be pro-growth. We admit to the same error, but we see things differently now.
If we suspend our belief system and allow the concept of ‘Rational Trump' to exist, what could ‘rational' - and hence, predictable - Trump mean. Trump was elected on a set of promises - such as cut taxes, quit the Paris Agreement, correct the trade deficit with China, build a border wall and make NATO members pay more. He has attempted and, in most cases, succeeded in fulfilling his promises.
This makes Trump's behaviour eminently rational: he is attempting to be a politician who ‘keeps his promises', in stark contrast to how he perceives the political establishment. This, presumably, will form a major plank of his argument for why he deserves a second term.
Trump is behaving like a classic ‘boss'. We spend a lot of our time attempting to read the behaviour of bosses. In a simple sense, we do not trust them. We believe the average boss is risk loving, highly confident, self-serving and likes power. When we view Trump as a boss, rather than as a politician, he looks a lot more predictable. Most bosses, unlike most politicians, do not try to get their way through persuasion, but through diktat.
So, we would frame Rational Trump as a diktat-driven boss who wants to win a second term by seeming to be a politician who keeps his promises and ‘can be trusted'. This places greater weight on non-economy drivers of popular opinion - ‘America First' and ‘the first politician who keeps his promises'.
A classic dictator tactic to maintain popular support, regardless of the economy, is to divert attention through acts of blame and aggression, orientated around nationalism and identity. This is why we now think it is dangerous to assume Rational Trump naturally implies he is pro-economic growth.
The unexpected US and China clash
Chinese economic growth is also important. Since 2009, we believe China has directly contributed almost 50% of global economic growth, with emerging markets contributing a further 25%. If the world cannot benefit from growth in China, growth becomes very hard.
Chinese growth, while well above developed economies, has been slowing. Two related factors have been at play. First, China's struggle to avoid the Developing Economy Low Income Trap. After an initial burst of industrialisation, developing economies have historically struggled to transition to more consumer and higher ‘value-added' led growth. Second, China is now attempting to clean up its shadow banking system and this is holding back growth.
Most of us were reasonably relaxed about China's ability to navigate both through 2018, albeit at a slower rate than the past. What we did not envisage was the clash between America's and China's view of how to break the low-income trap: America wants China to consume more American goods, China wants to compete with America in IP and high, value-added industries. The result is a trade war.
There has been a significant reframing of how America views its relationship with China during 2018. For 20 years, China has been viewed as an opportunity. Now it is viewed as a competitive threat. This is a fundamental shift. It has just cause, and herein lies a paradox. China cannot easily break the low-income trap without striving to become a competitive threat. Rational Trump would argue competition is fine, as long as it is ‘fair', hence the trade war rhetoric. However, we are pretty sure every successful developed country has resorted to distorting trade practices at some time to allow their chosen industries the chance to win.
What to expect in this year
We are not fancy hedge fund managers. We invest our clients' money in the stock market, trying to give them a better outcome than an index fund. We attempt to achieve this by picking better stocks, not by trying to decide when to be in markets and when to be in cash. When we are nervous about life we like to spread our bets and focus on what can go wrong.
After over 30 years in stock markets, we still believe there are plenty of good companies out there which can survive almost any conditions and prosper in most. However, for what it is worth, we think the outlook for 2019 hinges on one key thing: what constitutes ‘success' for Trump in his trade war with China. If he can claim victory quickly then there will be growth and markets will be fine.
Regardless, the world will not be the same. We think a new cold, economic war has started with China which will create a more fragile general environment for global growth.
Jeremy Lang, partner and co-founder of Ardevora Asset Management