The mood at Davos was the most divergent it has been in years. Some American bosses were notably bullish about accelerating economic growth and a regime change in fiscal, regulatory and trade policies. Others, particularly some European policy makers, were markedly downbeat. But whoever you spoke with, the intense political and economic challenges from populism, globalization, disruptive technology, the migration crisis and inequality dominated debates. While consensus was less confident on how to navigate the risks, it likely acts as a catalyst to drive change.
Conversation was dominated not only by who was there, but by who was not. President Trump was the dark matter of Davos. Dark matter is not well understood but occupies 95% of the universe and has huge gravitational pull. The implications of Trump's presidency reverberated around Davos.
1. Automation and jobs
I sense a step change in the perceived level of threat to jobs from automation and the Fourth Industrial Revolution. Consultancy McKinsey shared new research suggesting 86% of manufacturing job losses in US between 1997 and 2007 were a result of rising productivity, 14% because of trade. What's more, some 1.1 billion workers and $15.8 trillion in wages are associated with activities technically automatable today.
Take finance. Bankers and insurance bosses I spoke with are responding to low growth and low returns with concrete plans for greater efficiency. This year’s Disruptive Innovation in Financial Services roundtable was telling – as it had moved on from prior years’ future scoping of blockchain and digital identity to a practical session swapping notes on how best to automate and manage partnerships with tech companies. One forecast from the session was telling: regulatory technology or “regtech” may drive a 50,000 fall in compliance jobs. At Davos I took a straw poll of executives at financial institutions and a range of other professional services firms I met which suggested they are looking to automate 10-30% of activities in the coming three to five years.
The implications for white collar employment and lifelong learning are huge. But tech leaders, such as Google, Facebook, were far more upbeat about the enduring ability of entrepreneurs to create new jobs which we haven't even thought of.
The impact of populism was the number one concern. How it manifests itself in the coming years is likely to be one of the most important drivers of markets. But I was struck by the lack of consensus about the causes of the politics of anger, let alone the consequences. The stagnation in real incomes and multiple challenges to economic and national identity are complex to solve. It was striking that China’s President Xi gave the strongest defence of globalization which has pulled millions out of poverty. So what does this mean for investing?
I suspect investing in Western markets is becoming more like investing in emerging markets - where a keen understanding of country risk and the political economy is important. Emerging markets also teach us populism is often inflationary.
Second, we need to invest through heightened uncertainty. The risk of tit-for-tat trade disputes was uppermost in many politicians' and executives' minds. There were understandably mixed views on Britain’s ability to forge trade links which are stronger than today.
But it’s not just about trade policy: the benefits of globalization of financial markets continue to be reappraised. I came away thinking that the Balkanisation of banking markets will grow as countries put up financial walls. Whilst a more compartmentalised banking system can help seal off shocks, it likely to be negative for growth unless markets can fill the gap. The banking crisis taught us Europe sorely needs more diverse funding markets for corporates and infrastructure, but my meetings made clear the Capital Markets Union, a European Commission plan to mobilize and channel capital, is on hold until Brexit is resolved.
3. Regime change
What does the regime change in policies mean for central banks and asset prices? The issue was debated vigorously. While most agreed the reflation trade, particularly in the US, is the most important inflection for asset prices in years – and probably the end of the 30-year bull market in bonds – there was little consensus on how smooth the transition will be. Given that we reached the practical limits of monetary policy in 2016, with the dangerous experiments in negative rates, it is little wonder that investors are optimistic about inflections in fiscal, regulatory and trade policy. The impact on asset prices, market liquidity, emerging market (EM) economies and EM capital flows was uppermost among the concerns of central bankers, bankers and investors. While conclusions varied widely on the scale of regime change, a few themes emerged.
I found support for my view that as central banks reel in quantitative easing (QE), cross-asset correlations should fall dramatically. Wider distribution of outcomes and more divergence of assets, sectors and securities performance could also be positive for insightful active investors.
Next, we should be thoughtful about assets which have been buoyed up by QE, especially if US rates were to rise more quickly if the stimuli prove more inflationary. Whilst markets have become accustomed to dovish central banks and “lower for longer”, exiting the extraordinary monetary experiment is far from clear and likely to drive far larger repricing and rotations. In the corridors, the debate about peripheral European sovereign bonds was uppermost. Fiscal policy has been largely dormant in the eurozone and whilst monetary policy can ease the burden, it is not enough to resolve structural problems. As a result, financiers feel the most likely outcome is for the European Central Bank to be dovish and taper slowly and we could still be stuck with negative rates until 2019. But the repricing of US 10-year bonds may limit their ability to do this. On the positive side, a recent increase in German inflation and increasing global growth could lead to a much faster reappraisal of European rates.
My meetings with policymakers and bankers also suggested a change in the approach to bank regulation as European policy makers become aware of how constrictive the Basel IV bank regulation process could be to European growth. Peak regulatory uncertainty, however, is likely behind us.
4. Long-term investing
The need to secure long-term investments through the fog of heightened uncertainty has shot up the agenda. One of the most interesting roundtables I joined was the meeting of Focusing Capital on the Long Term at Davos which brought together asset owners, investors and CEOs on how to promote more long-termism in investing. New draft research for the meeting suggested that long-termism could have added five million more jobs in the US and created $1 trillion of additional value. But uncertainty risks driving business decisions to be more short-term. Sir Martin Sorrell, Chairman of WPP, and Kevin Ellis, Chairman of PwC UK, debated this further on the BBC the day after. For instance, in five of the last six quarters S&P 500 companies paid out all their earnings in dividends and share buybacks, rather than materially increase investment.
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Practical and policy steps can be taken to reduce excessive short-termism, but two broader tensions in long-term investing kept coming up over the week. For the more bearish institutions, it was an underlying nervousness about what is the right risk premium one should place on a 10 to 30-year project given the heightened political and economic uncertainties. This was most acute in Europe and I had the opportunity to debate with the British Chancellor how best to help companies and investors look through what he called the "Brexit fog". For the more optimistic investor, the concern was rather that as the global economy recovers and inflation increases there may be a far bigger repricing of interest rates, and so wanted to hold on for higher returns. But what bodes well for economies is the huge focus on companies capitalizing on long-term themes - particularly tech and healthcare - and a far greater focus on the social impact of their investments.
How to improve forecasting - in a series of workshops - was the surprise success of Davos 2017. At a time when the value of forecasting and opinion polling is under serious question, it was uplifting to have such an insightful series. This involved recognizing and adjusting for biases, reducing group think and echo chamber effects, incorporating a wider range of novel data insights, and simply learning from errors. It reinforced by contention that central banks made errors in part by assuming a frictionless economy free from credit booms and busts and ignoring banks and financial multipliers. Their models were, by construction, fairweather models and when the crisis hit they had no useful framework to turn to, and so had to turn to financial history. While some progress has been made, I am struck that one of the biggest policy mistakes of 2016 was negative interest rates, signalling that there is still plenty to do.
One of the speakers suggested that the problems in social sciences have come from over-emphasis on the advancement of complex theories rather than a focus on solving practical problems. As an investor, this chimed with me. Harnessing data insights to solve investing problems is critical to maintaining an investing edge. As we agreed: “no man or woman can beat a machine, but no machine can beat a person with a machine.”
One can never do justice to the richness and breadth of the extraordinary debates and conversations in a postcard. I find the Annual Meeting in Davos provides a good opportunity for an exchange of views on macro and micro issues. It deepens my understanding of the views that are embedded in asset markets and what's on the minds of policymakers, investors, tech entrepreneurs, financiers and industrialists. For more on my take see:
Sir Martin Sorrell (Founder and CEO of WPP), Kevin Ellis (UK Chair of PwC) and I debate Davos themes and the future of long term investing on the BBC Today programme (from 16.00 mins to 27.30 mins)
Tom Keene, Francine Lacqua and I debate Globalization and Finance into Davos on Bloomberg: Van Steenis: Globalization Going From Growth to Walls and Van Steenis: Banks Can’t Cut Their Way to Greatness
My take on how to improve economic forecasting, published in the Financial Times (paywall): Why central banks need some friction in their models