One week / one topic: Marooned

What happened?

“Toto, I have a feeling we are not in Kansas anymore…”

Almost anywhere you look, markets are behaving in ways that are very different from what you would have seen in the past.

To start with, equities sit at all-time highs despite trade and kinetic wars, expensive valuations in the face of slowing macro data, and stubbornly high interest rates.

Within fixed income, credit spreads remain very tight – therefore mirroring the exhuberance displayed by equities as well – while government bond yields have been rangebound for almost two years. (Japan, as usual, is doing its own thing)

Currencies – starting with the dollar – are seemingly not linked to interest rate differentials anymore, and are apparently (?) responding to very hard-to-pin-down structural concerns.

Market to investors: what are you going to do about it?

Investors: Erm… let me have a think?

Our observations

• Fundamentals: If the past is not a useful guide anymore (temporarily, perhaps?), should investors stick to their core beliefs about how markets work or adapt to the times? The jury is out…

• Price action: At least to my eye, price action is saying that we are in a very different environment compared to just a few years ago. At some point, ‘old-fashioned’ fundamentals should provide anchoring once again… but the bar seems to be shifting higher and higher.

• Investor beliefs: Many investors feel more than a bit lost in this market environment, and understandably so. Misery loves company, yes – but the world doesn’t stop while you try to figure things out.

So what?

Unfortunately – when reality does not comply with one’s preconceptions or past experience – there aren’t any comfortable options to pursue.

You could stick to your guns, and hope wait for ‘fundamental rules’ to reassert themselves. You also get bonus points for avoiding style drift and delivering ‘what it says on the tin’ for investors … but you do risk irrelevance and obsolescence as markets evolve.

Alternatively, you can (try to) change with the times – but then you face the challenge of very small sample sizes (how confident can you be that things have indeed changed, when you only have a few observations to rely on?), plus of course the psychological burden of changing one’s worldview.

To boot, President Trump remains a bottomless volcano of policy uncertainty – and for the time being, in the absence of any big macroeconomic developments, what he says does indeed move prices.

All in all, it seems that being more tactical – i.e. smaller position sizes coupled with more frequent reassessments – should be a sensible course of action, at least until you get an unequivocal sign that something meaningful is indeed happening.

Such moments are few and far between, however, and you need to manage the interim periods of course.

In other words, let’s not wait for ‘hero trades’ and accept that we have to grind it out… as painful as that may be.

Mood music: Pearl Jam – Oceans