There is no knowing without believing, and believing is the way to knowing...
It’s hard to believe, but the S&P 500 remains relatively flat week-to-date, month-to-date, quarter-to-date, year-to-date, and really has been on auto-pilot since the end of 2014! With U.S. 10-year Treasury yields 80 basis points (bps) lower and gold $140 higher as compared to the end of 2014, how many would guess rightly that the stock market would today – after two years – be languishing around unchanged?
Currently, markets are waving off dust that is far from settled including: another earnings season, middling worldwide growth, exhausted monetary policy measures, political instability and very aggressive 2017 earnings assumptions. Are investors scared? Should investors be scared? Or, have they obtusely preferred not to fall for the “banana in the tailpipe” trick again in that similar to the angst of August 2015 (Chinese surprise currency devaluation) or February 2016 (recession fears), the latest -5.7% two-day cratering of the market (Brexit) was met with immense fervor, pulling the S&P 500 back to the same ledge it was perched on for most of June.
The most recent V-shape snap-backs could mean something or absolutely nothing. Is the framework for the equity markets perfect? No! Particularly compelling? No! Perhaps it’s nothing other than a migration away from the seven-year tendency for investors to conflate short-lived economic disruptions with real, granular changes in the fundamentals. In other words, perhaps we’ve stopped comparing every event to Lehman Brothers!
There is no doubt the present marketplace is riddled with the stickiness of selection and the command of preference. But for those willing to receive it, our current state of affairs can be a long-lasting and fruitful gift. No doubt the obstacles often stand taller than we realize and our best words fall short.
Here are some random thoughts to help encourage investors through our current market confusion.
Causation Not Correlation
Search for causation, not simply correlation. Example: As beer sales increase, the rate of drowning deaths increases sharply. Therefore, beer drinking causes drowning. This is correlation, not causation. On the other hand, if S&P 500 2017 earnings-per-share estimates drop from $130 to $110, then the stock market should correct. The fact that lower earnings-per-share causes an effect is causation!
Watch Not Volatility But Volatilities Vigor
Both the intensity and the frequency of investors’ changing beliefs about market fundamentals will directly affect stock market volatility. When investors’ sense of what the future holds is in flux, stock prices and option volatility will change rapidly, frequently, and significantly. This lesson is not necessarily intuitive, since one might expect uncertainty to generate only tentative volatility oscillations rather than huge waves of selling. However, such irrational behavior is what causes an investor to be convinced on Monday that the world is ending and by Friday to be equally convinced that the world has weathered the storm.
Don’t Look In The Rear-View Mirror
The next wave of crises is sure to be different from the last. Money is made and money is lost in crises. Those who lose money typically set up safety measures to avoid incurring loss in the same fashion twice. As institutions evolve, those who profit during crises and other periods of volatility look elsewhere for weak points. From this simple dynamic, it follows that the next series of financial crises will be distinctive and different from previous debacles.
Verify And Don’t Trust
Don’t automatically trust the person on financial television (CEO, CIO, hedge fund guru, etc.) just because he or she is on television. If they are so smart, why do they need so badly to tell you? Similarly, be extra wary of those in media who relish their good calls and dismiss the bad ones. In my January 4, 2016 column, Warning about Tomorrow: A 2016 Market Forecast, I can bask in my boldness to depart from consensus in calling for a lower U.S. dollar and higher gold prices. Yet somehow I can simultaneously manage to sweep my call for higher 10-year Treasury rates under the rug.
What seems to be happening in our investing media culture is a falling apart, a disconnection between the subjective and objective poles. We have an illusion – a type of objectivity being spewed, of a kind of knowledge of what we call the “facts” which involves no personal commitment, no risk of being wrong, something which consumers have merely to accept without question. This is a mark of a tragic loss of nerve and respect in our current investing culture. To me it is a preliminary symptom of investor insanity and it causes me to dread what lies ahead.