A 2020 Word Cloud

As everyone knows, Christmas gets earlier every year. In New York, the flagship store of Macy’s will unveil its Christmas window displays on Thursday—more than a month before Christmas and even a week before Thanksgiving, when it sponsors a nationally televised parade through the city’s streets.

But it isn’t just department stores. The annual ritual of large investment houses unveiling their predictions for the year ahead has also nudged earlier and earlier. In mid-November, the season is already in full swing. You might think that 2018 had been a cautionary tale, when the biggest sell-off of the decade brought the S&P 500 down more than 20% from its peak, and culminated on Christmas Eve. All the 2019 forecasts were already out, and suddenly what had been estimates of a rather flat year in 2019 had been turned into prognostications of a 25% gain. 

This episode may have dampened the ardor of strategists and fund managers for making precise numeric predictions. And it also dampens my own ardor for going through those outlooks in detail. But it hasn’t stopped investment banks and fund managers from launching lavish productions. My favorite so far saw a panel of experts from UBS Group AG at New York’s Four Seasons hotel joined by a hologram of their Asia-Pacific strategist Min Lan Tan, who took part without ever leaving Singapore. 

Through all the words and beautifully presented PowerPoints, some themes are emerging. I haven’t crunched all the transcripts, but I am confident that a word cloud of all the presentations I attended would feature some of the following words in big capitals:  

WARREN

Senator Elizabeth Warren’s name arose repeatedly, as one of the biggest risks for next year. If presenters didn’t bring her up spontaneously, there would be a question about her. Sectors she could most affect are financials, energy and healthcare, in that order: M&A will dwindle because she would be tougher on antitrust; and nobody felt like making strong predictions either way about her chance of winning. One intriguing way to benefit from a Warren presidency might be to try investing in ESG funds. If a President Warren is going to force us all to buy ESG investments, the argument goes, then buy ESG funds now and enjoy a pop when she makes everyone else join in.

To give a notion of Warren’s impact, I recall no mention of the words Biden, Sanders or Buttigieg, even though these three are all in a rough tie with her in polls in Iowa. Her name came up even more than the word Trump. To some extent she stands to play the same role that Trump did four years ago. A year ahead of the election, discussion revolved around him, with many openly terrified of the prospect of a Trump victory — so that of course there was a dramatic rally as soon as he won. Like Trump, Warren represents change and the unknown, along with a risk to the current model of capitalism that is serving money managers and their clients very well. One related issue:

INEQUALITY

A year ago, the concern was about “populism,” generally taken by investors to be a bad thing. This year, there is more of a direct focus on inequality, which is acknowledged as a serious problem — and also as a risk that could yet bring capitalism as we currently know it unstuck.

There is less inclination to talk about Warren’s plans to attack inequality with a wealth tax. The press debate of the last few weeks has probably convinced the investment community that nothing good can come of complaining about extra taxes for billionaires.

RECESSION

I heard few clear-cut predictions of a recession next year. But the word recurred repeatedly. To the risk of an economic recession in the U.S., add the risk of an earnings recession, and of recession in the eurozone. Almost no one believes this is a good time to buy cyclical assets. Discussions focus on defensive assets with recession-proof revenue streams, and on whether these are now too expensive. The hunt for yield is still on, a decade into the economic expansion.

While there are anxious discussions of the macro-economy, there is notably little belief that policymakers can do much about this. There appears to be an uneasy consensus that central banks have done more or less as much as they can. What happens next is in the lap of the gods, or consumers and industrialists making their decisions, or possibly even voters. 

HUAWEI

There were startlingly few references to Europe or Japan. The only time I heard the word “Brexit” was in a self-deprecatory comment from an Englishman. But China is front and center. There appeared to be little deep belief that a trade truce would create much of a reason to buy stocks or other risk assets. Instead, there is a concern about the deeper source of the U.S.-China conflict, over the safeguarding of intellectual property, and the notion that China has stolen American ideas and jobs. Huawei Technologies Co., the telecom equipment manufacturer, is the poster child for the dispute over intellectual property. Buzz words like the risk of a “Silicon Curtain” to divide the world as the Iron Curtain once did are also floating around.

What can investors do to protect ourselves? Most seem to think the U.S. and China are likely to survive relatively unscathed. Investing in companies that will benefit from a likely increase in spending on IT in China was an interesting idea from UBS’s Tan, who also suggests looking for beneficiaries of supply chain resets, such as Vietnam and other parts of emerging Asia. I would add Mexico, which has an obvious logistical advantage. 

THEMES

The best way to sell anything is to tell a story about it. The brain finds it easier to understand a concept if it is draped around a narrative or something visual, rather than numbers or abstractions. Narrative Economics, the latest book by Nobel laureate economist Robert Shiller, delves into the importance of stories in explaining market phenomena.

Thematic investing, or the idea of looking for some big social narrative and then finding investments that will do well as a result, has been around for a while, but it is growing ever more important. This year, there seems to be more emphasis on spinning tales that could help to illustrate what is about to happen.

So there is plenty of talk about demographics, robotics, gene therapy and other compelling if sometimes alarming narratives. Mark Haefele, chief investment officer of UBS Global Wealth Management, suggested that a unifying long-term theme makes it far easier to keep with a strategy for the long term, and to maintain discipline. If people always have their eyes on one unfolding plot, it is also easier for them to make adjustments to their portfolio over time, without losing consistency.

Thematic investing sounds a little like a fad. But it might make sense as a way to frame all our investment decisions simply because it accords much better with the way we think. That insight might be worth more than an attempt to provide a guess of where the S&P 500 will be at the end of next year to two decimal places.

The Dangers Of An Extrovert CEO

One of America’s most famously dirty election campaigns took place in Florida in 1950. The winner in its Senate contest branded his opponent in sinister-sounding terms. “Are you aware that Claude Pepper is known all over Washington as a shameless extrovert? Not only that, but this man is reliably reported to practice nepotism with his sister-in-law, and he has a sister who was once a thespian in wicked New York.”

This anecdote found it way into all the obituaries of Pepper, who would live to mount a political comeback and spend many years as one of the most powerful men in Congress. I was disappointed therefore to discover today that it wasn’t true—a spoof piece in a magazine, meant to ridicule Florida voters, was taken at face value and found its way into the press cuttings.

I mention this because new academic research has crunched piles of numbers to show that we should all avoid companies if their CEO is a shameless extrovert. Based on 2,880 CEOs of S&P 1500 firms from 1993 to 2015, the research used data mining to examine CEOs’ Q&As with investors and analyzed them to see where they scored on three important personality traits—conscientiousness, neuroticism and extroversion. It then did lots of mathematics to isolate the effects on stock returns and risk. (The research is titled Perception Is Reality: How CEOs’ Observed Personality Influences Market Perceptions of Firm Risk and Shareholder Returns.)

A conscientious CEO reduces stock risk by a statistically significant amount. When a company faces risks from one standard deviation below the mean to one standard deviation above, they will lead to an improvement of 3.83 percentage points compared to the norm. The less conscientious CEOs will see their companies’ returns fall by 1.7 percentage points compared to the norm.

Neurotic CEOs, it should be no surprise, tend to increase the risk surrounding their companies. But the interesting results concern extroverts. Without naming names, there are a number of high-profile shameless extroverts running some very large companies at present, and there is no need to mine call transcripts to spot them. 

The more extrovert the CEO, the more a stock’s price will tend to vary. This makes for a bumpier albeit more exciting ride. Most importantly, an extrovert CEO has a huge effect on returns once a company takes on high risks. The researchers looked at the effect of moving from one standard deviation below to one standard deviation above the norm for risk. All else equal, a very introverted CEO can help increase returns by 5.43 percentage points in such situations, while the same increase in risk will reduce returns by 3.3 percentage points under an extrovert.  

There is a clear narrative for this. Boards should not mistake shameless extroverts for great leaders. And unlike the tale of the 1950 Florida election, this isn’t an urban myth. 

This article was provided by Bloomberg News.