The arc of history and markets

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Stories from the big market

On the Apple TV show Foundation, based on the novel by Isaac Asimov, the plot is set in motion by a mathematician who, using a sophisticated algorithm, predicts that the centuries-old galactic political order is doomed to collapse. Like the premise of any good science fiction, this one is intellectually unconvincing and emotionally compelling. Unconvincing, because societies are dynamic systems which evolve with the beliefs of their populations which are their constituent elements. The idea of ​​definitively predicting them with a bunch of equations is about as likely as faster-than-light travel. Convinced, because in the real world people have always been attracted by the dream of historical order and predictability.

If you doubt whether anyone is truly falling for the grand historical algorithm that predicts the very big thing that is about to happen, I suggest you read Francis Fukuyama’s review of “The Fourth Turning Is Here” from Neil Howe and “End Times” by Peter Turchin, in the New York Times. Turchin’s book is based on what is called “cliodynamics”: in Fukuyama’s words, “a variety of Big Data analytics that make predictions by applying mathematical models to a huge database of past historical crises dating back several millennia. Described in this way, the method is indistinguishable from the “psychohistory” of Asimov’s mid-century imagination.

On Wall Street, some great theories and historical stories come from investors who have made a lot of money, which gives them credibility. It is tempting, for example, to take seriously George Soros’s theory of reflexivity or Ray Dalio’s discourse on the five great forces of history as predictive frameworks. But good investors are no better than us at seeing the future; their skill is an acute understanding of the present. Every time someone starts with “I’ve been reading a lot of history lately…” ask the waiter for the bill.

And yet, we must try to see as far as possible. To the extent that we believe that economies and markets are amenable to analysis, it is natural that we try to anticipate not only cyclical changes but also regime shifts. The latest to take the plunge are Jim Reid, Henry Allen and Galina Pozdnyakova of Deutsche Bank, who yesterday published the third part of their study on long-term asset returns, entitled “The History (and the future) of recessions”. The study is long and detailed and contains many useful graphs and tables on the frequency, depth and duration of recessions in developed markets going back decades and even centuries.

The forward-looking argument of this article is that the post-1982 period of falling rates, low inflation, and long economic expansion is historically abnormal and probably over. This period was characterized not only by increasing globalization, but also by proactive fiscal and monetary policy that mitigated economic recessions and led to a large accumulation of debt.

But now,

[T]his approach comes up against increasing limits. In particular, the public and private debt burden has reached very high levels, which limits our room for maneuver in the future. At the same time, real yields have risen sharply in recent years, driving up the cost of additional debt. And with [ageing demographics and deglobalisation] continuing to exert upward pressure on inflation, the coming years may well be marked by more volatile interest rate movements, and therefore more volatile business cycles. This will likely place more constraints on policymakers. . . a more regular pattern of boom-bust cycles and more frequent recessions are likely

This new regime won’t necessarily be bad for growth, Reid and his co-authors say. Indeed, there is a strong tendency toward market fundamentalism in the report, suggesting that a “natural” economic cycle will encourage innovation and growth through creative destruction. And in a nice nod to the indeterminate nature of history, the authors also argue that one of the reasons for the long business cycles of recent decades is pure luck. In the past, many recessions have resulted from disasters, wars, pandemics and other endogenous shocks, and “the fact that we have only had four recessions in the United States in the last four decades is very unusual and it is unlikely to happen again without a huge impact.” good luck “.

Long-time readers of Unhedged will recognize another important feature of this thesis: Many people agree with it, or at least have opinions closely aligned with it. Among those who have the nerve to predict economic regime changes, this is close to consensus. This shares much with Charles Goodhart and Manoj Pradhan’s demographic argument about interest rates. This is a toned down version of Nouriel Roubini’s prediction of a stagflationary debt crisis. This is very similar to the BlackRock Investment Institute’s view. Bank of America’s Michael Hartnett argues for a similar set of results. The list goes on.

The teenager in me responds to the popularity of this prediction by doubting it. I just don’t think people tend to get big calls like this, and the fact that so many people are drawn to this particular call makes me wonder if the appeal of the story lies in its cleanliness rather than in its rigor. My attitude does not deserve to be called a counter-argument, however, and the Reid Report and its predecessors contain a lot of solid work.

I suspect, however, that part of what drives the consensus on regime change is awfully simple. It’s hard to look at a long-term chart of U.S. interest rates without thinking that we’re about to experience a regime change that causes rates to rise. Here is Deutsche Bank’s version of the chart:

Line mounted from 1950 to 1982; the line goes down to the zero limit from 1982 to 2020; now the line must go up! It’s not an argument either, but at least it’s not science fiction.

A good read

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