Suddenly many of the fixed points by which investors were navigating have shifted drastically.
Market participants find themselves like sailors in the fog who discovers they’ve been taking a compass bearing, not on a lighthouse but on wandering flotsam. Additionally, we seem to evermore live in a world of unreason, where right and wrong have been condensed to personal preferences, which can be easily wrought by smooth talk – like the verbal shift which says “credit” when it means “debt” or “accommodation” when it means “print money” or “portfolio diversification” when it means “compounded convergence risk” and the equivalents of that exist in every domain – and where people don’t need to think because they can drift along with the present aura.
Living life in neutral is easy! Investing in neutral can be deadly!
Market Narrative and Changes at the Margin
It isn’t so much that any one specific and dramatic event occurred in the last month, but instead market positioning has grown extremely crowded based on belief systems that had grown very complacent and stale ultimately buckling under the steady accumulative weight of data that frankly didn’t support the price movements. Layer on top of this a low-volatility environment combined with the severe lack of fixed-income liquidity and a heavy dose of complacency - making moves more violent than they normally would be.
In response to all of this, nominal growth expectations have risen or, perhaps stopped falling and consequently bond yields continue rising. The German bund move has been the most vivid example where 10-year yields just three weeks ago were near 0.5bps (basis points) but are now just north of 0.40bps; still dangerously low yet a powerful swing in such order. And, as things have gone of late, European borrowing costs have been a cotter pin on borrowing costs globally; as they rise or fall has a direct domino effect in the United States.
Tying all this back to the U.S. stock market is thorny yet, confidence is still rather steadfast and unmovable as evidenced by the most recent market jolts we’ve experienced. While the S&P 500 is 30 points from its recent high, the mixture of an extraordinarily accommodative Federal Reserve, appealing equity valuations, easing of civic tail risks, and the hopes of improving economic growth is the principal catalyst behind the most recent performance. So despite episodic growth scares, frequent bouts of political dysfunction, and an ever-changing policy backdrop the sturdy recovery of the US economy and corporate profits have done wonders to keep equities afloat and comfortable within this wide and laborious trading range.
Other words, although the U.S. economy has consistently failed to reach the growth rates that economic forecasters have been looking for there is presently just enough momentum in both employment and real income to hint that 2015 is another year of mushy growth is more likely than a downturn.
The “On-Side” Investor
I find today’s market culture surprisingly similar to U.S. culture at-large in that most are quite cozy going with the flow of history – the flow of things as it were. For the most part, the press, politicians, social media, and music are basically “on-side” and culture is saying that unless you support this or that, you’re on the wrong side of history – the wrong side of things. This vague mentality has brought to my mind Nikita Khrushchev’s 1956 provocative claim that, “History is on our side and we will bury you.” It’s a dangerous mentality – a rhetorical smokescreen - one slithering under the doorway and ultimately intoxicated an investor class with the poison of complacency.
Reality is markets spent the last month in a trance, hypnotized by the idea that global central banks would simply be accommodative as ever – forever. Yet, the tone changed swiftly as the Swedish Riksbank didn’t cut as many thought it would. The U.S. Fed last Wednesday also didn’t explicitly rule out a June lift-off as markets thought it would and expectations on additional Bank of Japan actions are getting tweaked
Weak US data, a bounce in oil prices and a pick-up in European growth: None of it came as a huge surprise, but it all weighed on positioning and the fallout has been seen in higher bond yields, a stronger euro, a weaker U.S. dollar and a rebound in the commodity-currency sector. Now we are back to waiting to see if the US economic slowdown will reverse in the coming months. While there remains a degree of “bad data is good for the markets”, increasingly this seemingly age-old proverb is wearing very thin or growing hollow as the time is arriving when stockholders will balance however many incremental months of zero interest rate persistent economic softness provides simply cannot compensate for the disappointment ongoing data weakness is likely to bring.
Dogma Versus Doubt in a Pluralist Market Culture
Pluralism is considered to be a proper and fitting characteristic of a society in which there is no official approved pattern of belief or conduct. A society not regulated by customary dogma but branded rather by the critical mettle which is ready to subject all dogmas to suspicious – if not critical examination. The present market dogma parallels too with popular society in that we’ve built a plausibility structure – a pattern of belief and thus, investment decisions accepted within a given society.
Today’s dogma includes – the super-technology sector will go up forever, social media and their stock valuations are here to stay, we will never see inflation or yields higher than inflation, the government will forever be able to reign in debt, America will continuously have a competitive advantage, the Fed can always print more money, stock markets can’t languish for a decade, diversification of stock sectors makes one truly diversified, or stocks don’t contain leverage.
Merely wandering/investing around in a clueless twilight is not seeking. If we consider what is involved in learning to know anything – especially the many things we don’t know – we will begin with accepting