Shifting narratives

The pull of a good story is irresistible for markets

“The future is certain,” starts the old Soviet joke. “It is only the past that is unpredictable.” Of course, this quip attempts to bring some levity to the government’s propensity for airbrushing history and controlling the narration over public perception.

But whether we like to admit it or not, investment markets share a similar dynamic: They are dominated by narratives. No, an authoritarian regime is not driving the message. Rather, it is what Scottish journalist Charles Mackay, nearly two centuries ago, called “the madness of crowds.” We are astonishingly prone to falling for our own stories; to believing our own propaganda. Regularly, investors become hostage to a dominant narrative – and often, it turns out to be dead wrong.

All this has become increasingly dangerous in today’s digitally-charged era. Online platforms often serve as echo chambers for already held beliefs, enclosing members in an intellectually impenetrable layer of like-minded peers. One’s world view remains one-sided with a cult-like focus on certain insider voices. Of course, it’s a trap. Never leaving one’s world presents a clear and present danger. New realities are never experienced. A potentially rich, textured subject stays one dimensional.

The dominant “narrative” now

What is the dominant narrative taking hold today? Undoubtedly, it is the notion that the global economy is on the edge of becoming unhinged – that the world faces a deep and imminent recession. In fact, a strong consensus now believes that policymakers overstimulated during the pandemic. Furloughed and fiscally-cushioned consumers also overindulged. Now central banks, spooked by inflation that was initially dismissed as fleeting, are being forced into aggressive rate hikes. A day of reckoning is apparently nigh.

Meanwhile, macro fault lines marble the entire globe. Supply chains remain tangled by Covid variants and war. Soaring energy prices have pushed Germany into its first trade deficit in more than 30 years. The avalanche of resignations the U.K.’s former prime minister, Boris Johnson, has just faced is more than any other British prime minister in history. China has turned to its old playbook of driving up growth through public infrastructure projects. And the investment world’s whirlwind courtship with cryptocurrencies is over, finally meeting their Minsky moment and destroying an eye-watering amount of wealth (if you are surprised, see me after class).

All of this has forged an easy fraternity for those predicting more macro doom. Global pessimism is now higher than ever. Understandably, the pull of this narrative is powerful. Because the most recent threats to civilization were a pandemic and then an unforeseen war, we expect the next one to take the same existential form. But should we? The history of markets is one of miscalculated extrapolation; of mistaking lagging indicators for the leading variety. And it is one of getting the big regime changes wrong. For years after 2008’s big downturn, most expected a global financial crisis to strike again. It didn’t.

On many levels, this makes sense. People’s perceptions of the past shape their view of the future. Old narratives take time to be replaced by new ones. Humans have a difficult time updating their mental models – overestimating the probability of what has already happened to them, while underestimating new scenarios.

That is why today’s investing climate is so dangerous. When the consensus is this strong, investors need to be on high alert to new narratives. These shifts can rapidly change market direction. Yet with inflation and volatility all at elevated levels, price signals become less reliable. The usual economic dashboard is blurry and distorted. As we wrote in the “The decade of living dangerously,” the risk of making bad investment decisions has exploded higher in the current environment.

At our recent webinar, we answered some of the key questions related to our theme. We’ll present some of these, starting with this article, and over the next couple of posts.

Question 1. Forstrong has been in the “recession not yet” camp this year. Given everything that has happened, do we still hold that view?

The recession question is an important one. To see a sustained extension of the current market downturn, we would also need to see a substantial downturn in economic activity. Large and widespread bear markets are just not typical outside of deep recessions.

But what is actually happening here? First, this is not a traditional economic cycle. We just witnessed the mother of all V-shaped recoveries out of Covid lockdowns. It should not be surprising that growth is now slowing. More importantly, investors are underestimating economic momentum out of the pandemic. To be sure, the consensus is right: Policy largesse during the pandemic was a significant shock, thrusting the low-inflation 2010s decade into a higher inflation regime.

But consider that the resulting inflation is now serving as a catalyst for more robust aggregate demand. A higher cost environment encourages government and business to invest in labour and energy-saving technologies. In fact, shortages have quietly kickstarted a robust recovery in capital investment. This was a key missing ingredient in the post-2008 recovery and is crucial for lifting capacity and productivity. This new virtuous cycle of rising capital spending and increased wages will lead to higher nominal growth. Eventually, this will mean stronger earnings and sustainably higher interest rates. Investors should expect a shallow slowdown now (we cannot call this a “recession” when the labour market is so hot) with a growth acceleration into 2023.

Finally, keep in mind that the interplay between markets and the underlying fundamental data is what matters. Right now, the recession playbook is currently driving market pricing. Yet markets can only price in a deep recession for so long without the underlying economic data validating it. Expect the mood of markets to change quickly.

Tyler Mordy, CFA, is CEO and CIO of Forstrong Global Asset Management Inc., engaged in top-down strategy, investment policy, and securities selection. The Forstrong Global Investment team contributed to this article. This article first appeared in Forstrong’s “2022 Super Trends: World in Transition” publication available on Forstrong’s Global Thinking blog. Used with permission. You can reach Tyler by phone at Forstrong Global, toll-free 1-888-419-6715, or by email at tmordy@forstrong.com. Follow Tyler on Twitter at @TylerMordy and @ForstrongGlobal.

Disclaimers

The foregoing is for general information purposes only and is the opinion of the writer. The author and clients of Forstrong Global Asset Management may have positions in securities mentioned. Performance statistics are calculated from documented actual investment strategies as set by Forstrong’s Investment Committee and applied to its portfolios mandates, and are intended to provide an approximation of composite results for separately managed accounts. Actual performance of individual separate accounts may vary with average gross “composite” performance statistics presented here due to client-specific portfolio differences with respect to size, inflow/outflow history, and inception dates, as well as intra-day market volatilities versus daily closing prices. Performance numbers are net of total ETF expense ratios and custody fees, but before withholding taxes, transaction costs and other investment management and advisor fees. Commissions and management fees may be associated with exchange-traded funds. Please read the prospectus before investing. Securities mentioned carry risk of loss, and no guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.