May You Live In Interesting Times
This Time it Really May Be Different.
Risk is higher. Markets are more unpredictable, and valuations more volatile.
Investment markets are subject to more than their share of exaggeration and hyperbole. Unique times rarely are. A series of “Black Mondays” turned into volatile and unpredictable times for only a few days. Unlike “Black Thursday” which sparked the depression and led to uncertain and draconian market conditions from 1929 to 1933, and then really didn’t improve much, with interspersed moments of favorable and unfavorable conditions, until post-World War II.
So, when anyone says “this time it’s different” it usually makes good sense to stop listening.
These days the markets have given us more frequent and intense volatility. The NASDAQ is down almost 30% so far this year, and shocks from the pandemic, the Ukrainian war, massive central bank interest-rate maneuvers, and China’s zero-covid policy, are all ongoing inputs for turmoil that will continue for some time.
Uncertain, Volatile, and Pervasive
May you live in interesting times.
Is it really different or just another “Black Whatever…?” Several measures indicate we have unique uncertainty these days.
Asset price volatility has been increasing and looks unlikely to moderate anytime soon. Forecasts are turning out to be less than useful because, along with unpredictable disruption, systems, processes, and global markets are also less predictable and, combined, this makes forecasts much less dependable.
Economic policy is becoming increasingly ad hoc and unpredictable, permeating the markets, and creating “interesting times.”
Stocks and Bonds Are Confused
In the past month, the S&P 500 composite index has been three times more volatile than prior to March 2020. The volatility index, “VIX,” that investors use to ensure against future stock price volatility, has been at 25 post-March 2020. Its 10-year average prior to that is closer to 15. While stock market volatility is not unusual, and the VIX has been at 25 before, the extended length and height of the VIX volatility index is unprecedented.
The bond market has been worse. A volatility index, developed by Merrill Lynch, is at its highest level since the unprecedented spreads caused by the pandemic in March 2020. The only time this volatility index has been at these levels is during the 2008 financial crisis.
This relatively unprecedented volatility for both the stock and bond market will create less predictability, more volatility, and valuation uncertainty beyond the comfort zones of most investors.
Central Bankers Could Help. They Aren’t
Central bankers, who were more typically the voice of calm and reason, seem to be acting with neither these days. There is hardly a unified voice among the economic oracles at the world’s leading central banks. Even within the Fed, there is a significant measure of disagreement among professional forecasters regarding economic growth, inflation, and other key economic metrics. Without agreement on the inputs, it’s hard to make a coherent and effective policy. We certainly aren’t seeing any of that these days.
Visions and revisions that a minute will reverse.
The economist John Taylor developed a rule, now commonly referred to as “The Taylor Rule” which gives a dispassionate algorithm as to Fed policy for interest rates via a simple equation. The only variables were inflation and the desired trend-line for GDP growth. Interest-rate policy was straightforward.
A rules-based system with dispassionate analysis is all but gone. Political meddling, multiple agendas, and theoretical “minor adjustments” that lead to wild and chaotic results are now at the core of rule-setting policy. A fantastical example, but unfortunately, close to more widespread reality, is that one analysis by the Fed, based on a series of seven “simple” rules, generated output suggesting that interest rates should be somewhere between 0.6% and 8.7%.
Rules, subject to discretion, meddling, modification, and “visions and revisions that a minute will reverse” generate absurdity.
Uncertainty and More Uncertainty.
Economic policy is scattered and unfocused, at best. An attempt at generating comforting regulatory commitment and stable economies has morphed into global uncertainty, and the fires of uncertainty are certainly fanned vigorously by confusing and unfocused economic policy.
Policy unpredictability has been rising steadily since the financial crisis and is more confused and disjointed than ever.
Expectations play an outsized role in determining outcomes. Low inflationary expectations lead to lower inflation. Expectations of economic stability enable business and capital spending decisions and strategic actions that enhance stability. Expectations for competent and reasonable policy create a virtuous cycle enabling stability and steadiness for growth and prosperity.
On the contrary, decreasing confidence in competence and reasonableness of economic policy leads to fragmented and self-serving actions generating more uncertainty and greater instability — a downward spiral.
This Is Not Ending Any Time Soon
All this adds up to much greater uncertainty. The combination of interest-rate policy, stock market volatility, earnings uncertainty, geopolitics, and global economic unpredictability fuel and reinforce even greater uncertainty. This downward spiral has a lot of momentum.
Political polarization adds to erratic economic policy, fueling higher inflation. The economy is more challenging to forecast, and central banks, trying to manage inflation and economic growth — remember the “Taylor Rule,” are adding volatility and uncertainty to financial market, scaring investors into unpredictable and often dysfunctional behavior.
Fragmented global trade and the unwinding of supply chains are encouraging unprecedented stockpiling and even greater booms and busts, magnifying the economic swings and spirals.
Persistent uncertainty creates higher costs of capital and less affordability, weakening business investment, slowing GDP growth, and reducing investment returns.
Hyperbolic “this time it’s different” statements are turning out to be true. This time days look darker, uncertainty greater, economic growth lower, vulnerability to additional shocks higher, and investors fear many more dark days to come.
More frequent and intense volatility will not be calmed anytime soon. It really may be different this time.