Back to basics
There is a danger that the investment world could pay too much attention to geopolitics in 2017. Although politics is important, there is a risk its current high profile could obscure more fundamental factors.
From an investment perspective, it should be remembered that the importance of politics is largely intrinsic. It has significance in its own right, regardless of any investment effects. It is possible to take a personal stance on an issue even if it has neutral or, indeed, negative consequences for returns.
The flip side of this is that investors should not let their politics cloud their investment judgement. Geopolitical shifts should be examined as objectively as possible when managing a portfolio.
In addition, the importance of investment fundamentals should never be overlooked. For example, corporate profits are the key long-term influence on equity returns. That is because equities are essentially claims on future earnings.
However, unconventional monetary policy has obscured their significance. A wave of cheap credit has artificially inflated asset prices. This has given the misleading impression, at least to those with a short-term perspective, that earnings are of relatively little importance. It is one of those situations where being a little older, and so having a longer-term view, can prove an advantage.
Even less well understood than investment fundamentals are economic ones. These are not the focus of everyday attention such as inflation or interest rates. Rather, the key determinants of economic vitality are corporate investment and productivity. Although these factors play a crucial role they are relatively little discussed in financial circles.
Productivity is the bedrock of economic health. The most fundamental indicator of an economy’s strength is how much the average employee can produce in an hour. It follows that, the faster the rate of productivity growth, the greater the level of economic dynamism. Yet productivity growth in the advanced economies has declined sharply since the 1970s.
Capital investment, in turn, provides the basis for increasing productivity. The application of new technology allows for a higher level of output per worker. However, investment levels, too, are weak in the developed world.
Such economic lethargy is important because it makes it harder to generate prosperity. For example, the ability to pay reasonable pensions ultimately depends on having high productivity levels. Wealthier societies can pay out more generous retirement benefits.
This truth is often obscured, as there is no simple correlation between economic growth and equity returns. That is because the relationship is a complex one. It is a grave error to assume growth does not matter.
Next year would be a good time to re-examine these fundamental truths.