The subtle art of picking the next economic X factor

IN 1982, economist Don Stammer first began to apply the term "X factor" to economics.

He referred to it then as "a powerful influence that was not even thought about when the year began ... but which had a big effect on business conditions."

So, by definition, it is something with an economic effect that is not reasonably foreseeable - a bit like a "black swan event", but it can be either positive or negative.

His first X factor was the unexpected surge in Japanese buying of Australian bonds in 1982.

He tells me that since then, picking the year's X factor has become a bit of an obsession. I can see why - we've been friends for many years, and have many a chat during the year about what the X factor might turn out to be.

He points out that being a fan of the X factor concept doesn't preclude one from taking a view on where the economy, shares, interest rates, property and exchange rates seem to be headed.

Rather, it's a reminder that investors need to allow for uncertainty and surprises - that these are inevitable. This is why diversification and awareness of risk are important to successful investing.

It's a reminder that investors need to allow for uncertainty and surprises.

Previous negative X-factors include the near meltdown of the global banking system in 2008, the terrorist attacks on the US in 2001, the sovereign debt crisis in Europe in 2010, and, in Australia, the immediate and serious impacts of the 2018 Banking Royal Commission.

The fallout from all of these is still being felt ... Just this week, Westpac and CBA were once again in the firing line for serious breaches..

On the positive side, the X factor for 2009 was the resilience of our economy following the global financial crisis; in 1991 it was the marked drop in Australia's trend inflation; and in 1988 it was the strong growth in the world economy despite the spectacular collapse of share prices (25% in 25 minutes) on 21 October 1987.

Don tells me there were many contenders for this year's X factor.

These included the fall in our interest rates without the Australian dollar plunging, extreme drought conditions in eastern Australia, the civil unrest in Hong Kong, the complexities of Brexit, and of course the unexpected outcome of our federal election in May.

But according to Don, the 2019 winner is "the strength of share markets, despite widespread and recurring fears on the part of many investors of an imminent deep global recession."

The fun really starts when we turn our minds to what the X factor might be for 2020. There is no shortage of contenders: the Hong Kong situation appears to be getting worse; Brexit is still causing chaos; there will be a US presidential election; and European pension funds are facing a bloodbath as bond yields keep dropping. Now add to this crazy mix the possibility of our Reserve Bank dropping rates to zero and introducing quantitative easing. And imagine an Elizabeth Warren win in America or a Corbyn win in the UK. You can see why the search for the year's X factor makes for lively debate around the Sunday barbecue.

Remember, by its nature the X factor will be unexpected. This is why I recommend we all stick with the tried and trusted principles: acquire top-quality assets, have your debts under control, keep adequate cash to cope with emergencies and market downturns, and spend less than you earn.

Noel Whittaker is the author of Making Money Made Simple and numerous other books on personal finance. noel@noelwhittaker.com.au

UP OR DOWN?: Picking next year's winning move has many variables.

UP OR DOWN?: Picking next year's winning move has many variables.