Financial markets are imbalanced and lack liquidity in crucial sectors, even historically stable and predictable markets such as the global bond and currency markets. Investments are slanted in one direction more frequently and the markets are vulnerable to big price swings as a result. These large global markets are not immune to ever more lopsided trades creating extreme volatility. This occurs even when a small change occurs in positions, sentiment, or news. Even the world’s most liquid markets, US dollar currency trades and US Treasuries, are seeing skewed positioning resulting in surprisingly large shifts in prices and Treasury bond yields.
The market now leans too far one way or the other, and that imbalance will be forced to reverse more powerfully and unpredictably.
Transformation, Valuation, Employment, and Deflation
Disruption to some of the world’s most important industries, deflationary pressure caused by scaling lower-cost businesses, and sustained low interest rates challenge traditional valuation models. Technological platforms, from blockchain-based businesses to energy storage to DNA sequencing, enable unprecedented disruption to business and economic models.
Interest rates will remain low, equity values will remain high, innovation will drive deflationary pressure, and volatility will be intense and frequent. A new approach is required to understand dynamic global competition and sustainable value.
A National Investment Authority, an idea gaining traction among the administration, would be responsible for “devising, financing, and executing a long-term national strategy of economic development and reconstruction.”
This is not the job of a government; this is the role of the free market. The market does this quite well, and government does this quite poorly. An NIA is another way to bring misery and inefficiency.
Policy reflective of central planning, socialism, or industrial policy brings misery to all. This discredited philosophy that tortured so many in Eastern Europe and Soviet Russia seems to be getting more traction today bewilderingly. It leads to nothing more than bureaucratic idiocy, waste, and disregard for any consumer needs.
Investors expected that the Fed would not only end its bond buying program, but many believed it would also raise interest rates. While the Fed did agree to taper its bond buying, essentially decreasing its $150 billion monthly bond buying program by $15 billion per month, ending the program in 2022. However, the Fed kept interest rates the same and clearly signaled that it would not raise interest rates anytime soon, and almost definitely not until the taper of its bond buying was completed – in other words, not for at least one more year.
Investors who had been betting on the Fed raising interest rates wagered on the yield curve flattening for Treasuries. Therefore, they invested in short-term Treasuries believing those would outperform longer-term Treasuries, as well as 10-year and 30-year bonds. Instead, we are seeing the opposite happen. Short-term bonds are dropping in price and yields are approaching their highest levels since March 2020. Meanwhile, prices for long-term bonds have climbed. This same phenomenon is happening for government bonds that only in the United States, but also in the UK, Canada, and elsewhere.
There are warning signs that the stock market is transitioning from some form of reality to misguided euphoria. The S&P 500 is up almost 10% in the last 30 days. However, this broad optimism doesn’t seem to be matched by many forms of fundamental reality.
Earnings are barely moving, and profit margins are under pressure from higher wages and rising product costs. However transitory one imagines supply chain constraints and lack of available workers, the situation has certainly extended much further than most predicted.
Central bank independence and fiscal responsibility matter, even though the Western world is acting as if these rules no longer apply. Well, perhaps. But the world has given us three examples where the consequences are extreme when these basic foundations of economic policy are ignored or violated.
Failures are essential for success. The NASA flight director, Gene Kranz, who is famous for the Apollo 13 quote, “Failure is not an option” has been misunderstood. Mr. Kranz did not mean “don’t fail.” He meant was that there will be a solution, think boldly and courageously because, while the solution may not be obvious to you now, you will find it eventually.
Accepting failures is not accepting failure.
Failures – trial and error, unforeseen roadblocks, creative thinking, visions, and revisions that a minute will reverse – lead to insight, innovation, creativity, and unforeseen breakthroughs. That’s success.
Decentralized finance (DeFi) can disrupt global finance – but only if Defi systems and central governments cooperate. Yes, sworn enemies cooperating for the greater good.
While each seems to be the sworn enemy of the other, ultimately, a cooperative relationship between decentralized and efficient (versus anachronistic and cumbersome) financial infrastructure and government central banks with stable currencies is absolutely necessary.
Defi transactions, to scale globally, require stable and predictable value. Government-issued currencies are the only reliable and foreseeable foundation. Cryptocurrencies, such as Bitcoin were never currencies. They are a sideshow that will remain a speculative asset, and increasingly unimportant.
Cryptocurrencies represent an architectural shift in how financial infrastructure and technology interact, and therefore, it is disrupting how the financial industry works globally. It is neither a new kind of money system nor a danger to economic stability. It is more important than that.
Investors have been swept up in the notion of “philanthropic capitalism” and have targeted life-sciences as an avenue that can fulfill this benefit to society. While laudable in concept, this is non-scientific surrealism. “Hoped-for” is not a reliable business model, and most of the unrealistic goals would not be sustainable even if achieved. Real science and innovation are more impactful and substantial and make life sciences even more.
Distinguishing what’s happening in the market and the direction of important market metrics – the signal – from garbled, inconsistent, and mostly useless data – the noise – is extremely challenging today. Information is contradictory and transient making data and critical events more confusing and indistinguishable. Unusual circumstances brought about by the pandemic, subsequent supply chain interruptions, inconsistent production and demand, and unclear economic forecasts combined for almost unprecedented uncertainty and unpredictability.
Typically, near-term predictions are reasonable and reliable because we have immediately available and fairly accurate data making short-term predictions reasonably accurate. In other words, we can estimate what will happen because we have a good idea what just happened. But this is not the case today. Predictions based on the near-term past are more muddled now than ever. While we used to be able to say we can see a trend, whether that’s inflation, economic growth, or some other important metric, too much volatility, irrelevance, and lack of applicability (after all, who is going to project from a base that includes a pandemic impacting global supply chains and production?), we really can’t reasonably rely on any of that data to try to find a trend or connect the dots generating a near-term forecast with any meaningful depth of data and understanding
More intense volatility occurring more often will be characteristic of this market from now on. An investment strategy must withstand and profit from this. The only clear signal from the market is that there is far too much noise and not enough of a clear signal. Without clarity, determining an investment strategy is flying blind with no instruments.
Core holdings combined with an ability to withstand and profit from volatility and unpredictability are essential for investors today.
