“Waiting patiently is an essential part of being an investor. And when you do take action, do it dynamically forcefully.”
–Howard Marks, Co-Founder of Oaktree Capital Management
Volume 19
Here We Go Again
The Certainty of Uncertainty
What Happened in the Markets
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In September 2023, we discussed the historical trend of market struggles in August, September, and October. This pattern has occurred frequently throughout market history and was evident last year. I mention this to remind us that these months often cause investors unnecessary stress, and they are right around the corner. Remember, markets always recover in time.
As we approach the final 90 days before the presidential election, we must be mindful of the heightened partisanship in America. When it comes to investing and our financial well being, it’s essential to maintain a balanced perspective and consider the recurring patterns that unfold over time. While history doesn’t repeat itself exactly, it does often rhyme.
In an election year, defense spending is expected to rise amidst market and policy uncertainty. Currently, at 3.6% of GDP, defense and space equipment production has increased by 14% year over year and is 11% above 2019 levels. Both political parties are willing to strengthen defense capabilities to support the economy.
The US will likely retain its status as the world’s largest oil producer. American oil production has surged to 13.3 million barrels daily, a significant increase from previous years. This growth has persisted through the Obama, Trump, and Biden administrations, suggesting that economic factors and global demand influence it more than presidential policies.
The budget deficit is projected to remain high at around 6% of GDP in 2024, with both parties reluctant to address major entitlement programs. The looming expiration of the Tax Cut and Jobs Act’s provisions in 2025 is expected to be a point of contention.
Interest rates are expected to stay elevated. With the federal government’s interest costs rising to 3.7% of GDP, higher than the historical average, the Federal Reserve will likely maintain higher rates. This is especially true given the strong economy and the improbability of the Fed returning to near-zero rates even in a recession. This scenario benefits American savers, who are seeing higher returns on their savings while foreign holdings of US debt
have decreased.
Finally, the US dollar’s dominance as the world’s reserve currency will likely persist. The dollar’s status is underpinned by the size and liquidity of US financial markets, a strong rule of law, and an open economy. Despite occasional concerns about the dollar’s dominance, its structural advantages ensure its continued primacy in global trade and finance.
In conclusion, while the political landscape may shift, the core elements of defense spending, oil production, the budget deficit, interest rates, and the dollar’s global role are poised to remain stable. Investors should keep these constants in mind as they navigate the complexities of an election year and beyond.
Have you ever tried to predict the weather a month in advance? You wake up one morning, glance at the sky, and confidently tell your friend, “It’s definitely going to rain on September 3rd”. Now imagine if you did this every day, with unwavering confidence, only to find out on September 3rd that it’s sunny. That’s the folly of certainty in a nutshell—assuming we can predict the unpredictable with absolute conviction.
The concept of certainty is tempting, particularly in fields like politics, macroeconomics, and investing. We crave definitive answers and predictable outcomes. Yet, as history has shown time and again, certainty is often an illusion. Let’s explore why embracing uncertainty can lead to better decision-making and why the quest for certainty is often a fool’s errand.
The 2016 US presidential election serves as a stark reminder of the hazards of certainty. Almost everyone was sure Hillary Clinton would win, and if, by some quirk, Donald Trump were to win, the stock market would collapse. The least certain pundits gave Clinton an 80% chance of victory, with estimates ranging upward from there. Yet, Trump won, and the stock market soared by over 30% in the following 14 months.
Such unexpected outcomes highlight the limitations of our models and assumptions. The response of most forecasters was to tweak their models and promise to do better next time. Howard Marks put it best and much more straightforward: “If that’s not enough to convince you that (a) we don’t know what’s going to happen and (b) we don’t know how the markets will react to what actually does happen, I don’t know what is”. This is the crux of the matter: we don’t know what will happen. Randomness exists, and it plays a significant role in shaping outcomes.
In 2021, the US Federal Reserve confidently predicted that the inflation then underway was “transitory”. They defined this as temporary, not entrenched, and likely to self-correct. Given enough time, they might have been proved right. Inflation could have retreated after the COVID-19 relief funds were spent and the global supply chain normalized. However, because waiting was unsound, the Fed embarked on one of the fastest interest rate increase programs in history, with profound implications.
By mid-2022, the media and economists alike were nearly certain that these rate increases would create a recession. History clearly shows that major central bank tightening usually leads to economic contraction rather than a “soft landing”. Yet, no recession materialized. Instead, by late 2022, the consensus shifted to the view that inflation was easing, the Fed would start cutting interest rates, and these cuts would prevent a recession. This optimism ignited a stock market rally that continues to this day.
However, the expected rate cuts in 2023 did not materialize. Despite a December 2023 “Fed dot plot” predicting three interest rate cuts in 2024, stubborn inflation has prevented any cuts so far. Yet, the stock market continues to hit new highs. This situation illustrates a crucial point: we don’t know what will happen or how markets will react. The optimists were wrong about rate cuts but benefited from the market rally nonetheless.
Conrad DeQuadros of Brean Capital provides an interesting tidbit on economists’ conclusions. He uses the Philadelphia Fed’s Anxious Index to indicate that a recession has ended. When more than 50% of economists predict a decline in real GDP in the coming quarter, the recession is over or close to being over. This paradoxical situation underscores that even the most educated guesses are often wrong.
In October 2022, I’m positive someone correctly predicted that the Fed wouldn’t cut interest rates over the next 20 months. If that prediction kept them out of the market, they missed a 50% gain in the S&P 500 index. Meanwhile, the rate-cut optimists were wrong about rates but are likely much richer today. Market behavior is notoriously tricky to gauge correctly, and the role of emotions and psychology often swamps the influence of fundamentals.
Despite experiencing several ups and downs throughout July, the markets once again demonstrated resilience in the face of volatility. Equity markets saw positive performance across the board, with the S&P 500 returning 1.2% for the month and an impressive 16.7% year-to-date (YTD). US small caps had an outstanding month, achieving a monthly return of 10.1%, bringing their YTD performance to 12.0%.
International markets also performed well, with developed markets posting a 2.3% monthly return (8.6% YTD) and emerging markets
achieving a 0.7% monthly return (7.6% YTD).
The fixed income sector also had a robust month, with the US aggregate bond market delivering a 2.4% return for July (1.7% YTD) and US Treasuries returning 2.2% (1.5% YTD). In comparison,
bank loans faced challenges, returning 0.7% for the month (4.4% YTD), while high-yield bonds returned 2.1% (4.3% YTD).
July’s market performance highlights the ongoing strength and resilience of both equity and fixed income markets, even amid challenging global events. The continued positive trends offer promising opportunities for investors while also reminding us of the
importance of strategic asset allocation to navigate potential future volatility.
Why do stock prices fluctuate more than the economies and companies they represent? The financial sciences assume that market participants are rational actors. Yet, the crucial role of psychology and emotion often makes this assumption flawed. Investor sentiment swings wildly—making market predictions notoriously unreliable.
Over the past 40 years, the standard deviation of annual percentage changes in GDP has been 1.8%, corporate profits 9.4%, and the S&P 500 price 13.1%. This increased variability in stock prices emphasizes the unpredictability of market participants’ emotions and behaviors.
Today, pundits are making all sorts of predictions about the upcoming presidential election. Their conclusions, while well reasoned and persuasive, are ultimately guesses. Intelligence, education, access to data, and analytical prowess are not sufficient for reliable forecasts. Many of these commentators possess these attributes, but they won’t all be right.
John Kenneth Galbraith once said, “There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know”. This quote frequently comes to mind when I hear confident predictions. Another favorite Galbraith quote from A Short History of Financial Euphoria addresses the “specious association of money and intelligence”. People often mistake wealth for intelligence, assuming successful investors have insights into other fields. Yet, success can result from luck or favorable conditions, not necessarily superior intellect.
It’s important to emphasize the significance of acknowledging uncertainty and recognizing our fallibility. Admitting “I don’t know” or “I could be wrong” promotes careful investigation, double checking conclusions, and cautious action. This intellectual humility can help prevent catastrophic mistakes, as oftentimes, we do not have all the answers and are simply trying to make our best educated guess.
The French writer Voltaire aptly said, “Doubt is not a pleasant condition, but certainty is absurd”. Certainty has no place in fields influenced by psychological fluctuations, irrationality, and randomness. Politics, economics, and investing are such fields. Predicting the future reliably in these areas is impossible, and overestimating our ability to do so leads to trouble.
Certainty is alluring, but it often leads to misguided decisions. Embracing uncertainty fosters intellectual humility, careful analysis, and better decision-making. As we navigate the unpredictable landscapes of politics, macroeconomics, and investing, let’s remember the wisdom of uncertainty. The only certainty is uncertainty, and acknowledging this can keep us out of trouble and lead to more thoughtful and informed actions.
So, the next time someone confidently predicts the future, remember the weather analogy: they might be right, but they might also be predicting rain on a sunny day. Embrace the uncertainty, and you’ll be better prepared for whatever comes your way.
As the Chief Investment Officer, Stephen Swensen oversees investment management, research, portfolio design, and all investment-related operations at Atlas. He also chairs the Atlas Investment Committee, guiding strategic investment decisions.
Stephen’s career began as a Financial Analyst for Deseret Mutual Benefits Administration (DMBA), a role in which he managed investments for a private pension fund and insurance company. Subsequently, he served as an investment analyst and portfolio manager for local Registered Investment Advisors (RIAs). Before joining Atlas, Stephen contributed his expertise as an Outsourced Chief Investment Officer (OCIO) for the Carson Group, supporting advisors on the West Coast. Educationally, Stephen holds an MBA and an MS in Investment Management and Financial Analysis from Creighton University. He has earned the Series 65 Uniform Investment Advisor License and is actively pursuing the prestigious
Chartered Financial Analyst (CFA) designation.
Beyond his professional achievements, Stephen is an enthusiastic hockey fan, both on and off the ice. He finds joy in playing the piano, golfing, reading, and outdoor cooking. However, his greatest source of happiness comes from spending quality time with his wife and four children
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