Don’t jump! Advice for goalkeepers from economic psychology.
Investors are wrestling with, among other things, the fallout from global supply chain disruptions, both labor distortions and energy shortages stoking input costs and inflation and escalating political rancor between China and Taiwan. The issues are well framed and understood. Markets rarely digest surprises and investor complacency is a crucial component for an orderly market. While hovering near all-time highs, most markets are in consolidation mode until we get some resolution and visibility on the associated outcomes. Last week we got some relief in the form of progress on the debt ceiling impasse and clarity on taxes. Still, risks remain asymmetrically weighted to the fundamental scale’s negative side, leaving most markets defensive in a choppy range-bound holding pattern.
Our weight of the evidence approach relies on confirmation from fundamental, quantitative, and technical disciplines. Fundamentals, some of which we’ve outlined above, remain murky. The lack of labor participation even as government subsidies wear off and wages rise sharply is inextricable. While the economy reflates, significant scarring resulting from the shutdowns is proving far more enduring than most anticipated. Just as the economy required intervention during the pandemic, it appears allowing the economy to simply “open up” was not sufficient to get business back to normal. Notwithstanding aggressive posturing towards Taiwan, China has established political reforms affecting businesses so onerous they undermine a reflating economy. As the second-largest economy in the world, a significant slowdown in China will dampen world GDP growth.
Our quantitative model is also not definitive. We always view the output in the context of the real world. Some signals are inconsistent with typical quantitative relationships among asset classes, currencies, and interest rates. Finally, technical measures have yet to assert themselves out of range-bound channels. We often use the term to describe the current environment as “no man’s land.” We’ve travelled a long road to nowhere, and still have little confirmation on key economic inputs. Often, the hardest thing to do is nothing. Sometimes people have an impulse to act in order to gain a sense of control over a situation and eliminate a problem. This has been termed the action bias (Patt & Zeckhauser, 2000). As such, we caution making any meaningful changes to exposure without sufficient confirming evidence based on our disciplined approach.
A world awash in liquidity seems to have pulled demand forward along with pushing higher the valuations of almost all assets. Never before have we seen such elevated levels of value across any and all strata – market capitalization, style and even asset class. It is through this lens that we focus on 2022. Leaders often lead to the downside and we are focused on anticipating any major shifts in leadership. There are many positive and negative consumer cross currents. Consumers have quite a bit of cash and savings, and the benefit of a generous employment market. Offsetting this are potentially increased taxes on investment portfolios. Investor perceptions and sentiment can play an important, sometimes decisive, role in the resolution (including direction, magnitude and speed) of markets caught in “no man’s land.” Their reactions to the markets can also shape future fundamentals. For now, we remain steadfast, vigilant, and protective.
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