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Investing Illusions: The Mirage of Market Predictions
Recession or no Recession? I don't know. And neither does anyone else
“All Perception is Projection”
The psychologist and Sigmund Freud protégé Carl Jung’s quote reminds us that we see what we want to see.
A laundry list of cognitive biases distorts our view of reality. You may have heard of some of these. Wikipedia lists several dozen.
Daniel Kahneman and Amos Tversky- two Israeli psychologists- received a Nobel Prize in 2002 in economics for uncovering a handful of them. (Neither had taken an economics course in his life)
You see this in the world of investing.
Look at the same data points, and you will see what you want to see.
Rabbit or Duck?
The Recession Debate
Today, the debate surrounds the question of whether a recession is imminent.
Follow financial TV news, business newspapers, or social media, and you'll see no shortage of recession calls.
These folks will go to great lengths to spin good data into something less rosy.
And for a long while, these fears seemed well-founded. Even Jamie Diamond of JP Morgan came out warning us of imminent disaster. He warned that a “very, very serious” mix of headwinds would likely tip the U.S. and global economy into recession by the middle of next year. That was in October oof 2022.
Outfits like Hedgeye- to which I am a subscriber- trotted out endless bearish scenarios with the clarion call of “are we bearish enough?”
It’s a slogan they have quietly dropped- though not their calls for a recession, which keeps getting pushed farther out.
As a chastened bear I no longer have a view on this.
But it does occur to me that whether a market or economic metric goes up or down, bears explain why the development was terrible regardless of the direction.
This is the case for two reasons.
First, analysts tend to fall in love with their forecasts. They have trouble letting go even as evidence piles up to the contrary.
Second, pessimism sells. And pessimism always sounds smarter than wide-eyed, naïve optimism.
Glass Half Full… Or Empty
The reality is that you can read economic data both ways.
It's the old glass half-full or half-empty phenomenon.
I came across an excellent summary of how all this applies to investing in TKer’s substack blog.
Let's delve into 11 everyday data points that, no matter their direction, can be spun into a tale of doom and gloom:
1. Oil prices: When they rise, it's a blow to consumer spending and a catalyst for inflation. But when they're on the decline, it's a red flag signaling a potential recession due to weakening demand.
2. Home prices: An uptick in home prices is a barrier for potential buyers, making homes less affordable. But when they're on the downswing, it's a blow to existing homeowners as their net worth takes a hit.
3. Walmart sales: When sales at the world's largest retailer disappoint, it's a bad omen for the economy. But when sales are booming, it's also a negative sign as it suggests consumers are financially stretched.
4. Lending activity: When businesses and consumers ramp up borrowing, it's a risk as they take on more leverage. But when they borrow less, it's also a negative sign as they're not leveraging their capital to maximize returns.
5. Short-term interest rates: When they're on the rise, it's a sign of worry about inflation and a tighter monetary policy from the Fed. But when they're falling, it's a negative sign as it suggests a slowing economy.
6. Long-term rates: When they're on the rise, it's bad news as borrowing costs increase, and the discount rate used to value assets goes up. But when they're falling, it's a negative sign as it suggests a slowing economy.
7. Market volatility: High volatility is a negative sign as it reflects increased uncertainty, something markets despise. But low volatility is also seen as a negative sign as it suggests complacency.
8. Consumer spending: When falling, it's a negative sign as it is a crucial driver of GDP. But it's also a negative sign when it's on the rise as it can be inflationary.
9. Debt ceiling: Not raising the debt ceiling is a negative move as it could lead to a financial market catastrophe if breached. But raising the debt ceiling is also a negative move as it allows the Treasury to sell many bonds.
10. Mega cap growth stocks: When the biggest stocks are underperforming the major market indexes, it's a sign of a sick market. But it's also a negative sign when the biggest stocks are leading gains as they could be masking weakness in underperforming names.
11. Student loan payments: Pausing student loan payments is seen as a negative move as it presents a moral hazard for borrowers. But when payments resume, it's also a negative move as it could cause consumer spending to dry up.
Here I am reminded of William Goldman’s comment about the motion picture industry:
“Nobody knows anything...... Not one person in the entire motion picture field knows for a certainty what's going to work. Every time out it's a guess and, if you're lucky, an educated one.”
The same can be applied to investing.