28 Feb 2017 5 min read

The future ain’t what it used to be

By Christopher Teschmacher

“The future ain’t what it used to be” is a quote often attributed to New York Met’s coach Yogi Berra, and is also one of Meat Loaf’s songs. The same applies to financial markets and investments. We can’t just rely on the past behaviour of markets to understand the risk we face in the future; that would be like driving a car using a rear view mirror. So what should we do instead?


When we sit behind the steering wheel and we hit traffic, we have to consider a range of possible routes to get us to our destination. In the case of managing portfolio risk, we must think about a wide range of possible forward-looking scenarios and abandon the idea of just a single most likely outcome.

The rear view mirror is nonetheless a useful tool when driving; the historical behaviour of markets is valuable as it includes crises, recessions, booms and busts. We can use periods of history to stress test our portfolios to see how they would have reacted. But to avoid relying completely on history, we also need to understand what risks and opportunities may present themselves in the future, which risks are elevated and how best to position for them.

Our aim is to identify the likely scenarios on the radar early, i.e. click the button in the hazard perception test as soon as you see it coming

Different tools are used to explore market scenarios; some simply stress the impact of a specific shock to a single asset. Others ask what a range of asset class returns will be if certain detailed economic scenarios play out. Finally there are event risks. Consider these the hazard perception part of a driving test. The event is certain to happen, e.g. an election, and there are limited distinct outcomes, with asset class returns under either outcome potentially looking quite different.

We don’t claim to have a crystal ball so our aim is to identify the likely scenarios on the radar early, i.e. click the button in the hazard perception test as soon as you see it coming. That way we can manage and position our portfolios according to the risks. We use our economists and strategists to take an informed view as to the likelihood of different outcomes. It’s more important to get this approximately right rather than say something will or will not happen. As evidence is received, such as updated economic data, or comments by policy makers, we have to review what we think could happen, and with what likelihood. 

The recent Brexit referendum and US election provide good examples of event risk, with quite distinct scenarios. What was important in the run-up to these events was keeping an informed view of the shifting probabilities. We look below at a short timeline of the US elections and Trump’s run from nowhere to the White House - the same has been illustrated with his changing polling odds in the chart above.

June 16, 2015
Announces Republican candidacy Trump announces his candidacy for the party nomination. In total 16 other major candidates put themselves forward. Trump's odds are close to zero.
February 9, 2016
First win: New Hampshire The start of a domino effect of further wins as other candidates around him drop out the race. The Republican party establishment, in general, attempt to rally against Trump but his odds begin to grow. By the end of March the Republican nomination race is down to just three candidates; Trump, Cruz and Kasich.
May 26, 2016
Presumptive nominee Trump has amassed 1237 pledged delegates from primaries and becomes the presumptive nominee. Our strategists have already started considering the probability of Trump winning. While his loosely defined policies didn’t give much to hold on to we looked at the ramifications of a possible Trump presidency.
July 21, 2016
Let the games begin Trump formally accepts the nomination despite protests from within his own party. The past week has seen a strong bounce in his election odds as damaging news flow against Democratic candidate Hillary Clinton sways voters in Trumps direction .
September 26, 2016
First debate The first of three debates between a well-rehearsed Clinton and a more unscripted Trump saw his odds of election plummet. His rise coincided with a weakening of Mexican peso against the dollar, his falling poll results saw the opposite. Market moves like this help us to refine scenario expectations as we can (to some extent) measure asset class moves with a change in polling averages.
October 7, 2016
That video tape Trumps odds hit rock bottom in mid-October, just weeks before the election. We maintain a higher probability of his election. At the other end of the scale, Clinton’s lead in the polls leads us to plan for a Democratic sweep of both the House and the Senate, a scenario we believed to have negative implications on risk assets.
November 8, 2016
The long night Going into election night, Clinton was still firm favourite. Whilst we agreed as a base case, we placed a higher probability on a Trump election than the market. The Democratic sweep on the other hand was virtually off the table. While the first results seemed to be going in favour of Clinton, the early hours of 9 November saw an irreversible tide of votes being counted in Trump’s favour. By 2:45am (EST) Trump was projected as the winner. We knew the overall market reaction towards risk assets would be a tug of war between the pros of Trump’s fiscal stimulus and the cons of significantly higher uncertainty. After the fact it was clear that excitement won out with “good Trump” priced into markets, although not for Mexican peso which took a huge hit. While some of our assumptions were not entirely accurate, being armed with scenario expectations before the event helped us to gauge the moves in key assets during the night.

While some of our assumptions were not entirely accurate, being armed with scenario expectations before the event helped us to gauge the moves in key assets during the night.

In 2017 we face a new set of event risks with a series of elections in Europe, the outcomes of which could test the EU’s long-term credibility. The focus is now on our ability to be responsive which means our set of likely scenarios and event risks will also evolve in shape and probability. Either way, we plan to be driving with our eyes looking forward, rather than in the rear view mirror.

Christopher Teschmacher

Fund Manager

Chris is something of a perfectionist which may explain the raft of automated spreadsheets ensuring charts are properly formatted to Teschmacher® standards. Having become the resident quiz master, he keeps his colleagues on their toes with a steady stream of investment trivia. This worldly Dutchman has wanderlust in his blood – he was born in Australia and has lived in London, New York and Paris. He has since settled in London with his young family, although regular trips to the South of France suggest that ambitions to become a vineyard owner are still strong.

Christopher Teschmacher