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Market outlook | Where are we and how we got here

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“Economists who have studied the relationship between education and economic growth confirm what common sense suggests: The number of college degrees is not nearly as important as how well students develop cognitive skills, such as critical thinking and problem-solving ability.”

A simple thought experiment

Imagine a hypothetical situation where a market participant is given exclusive access to the FOMC statement half an hour before the official release. Setting aside the legality and ethical questions, what percentage of market participants do you think would know what to do with it? And what percentage would have the courage and conviction to put on a trade on the back of the information?

We estimate that less than 10% of all market participants would know how to interpret the FOMC release. Less than half (5%) can make an objective assessment without projecting what's already on the books. And less than 1% would have the courage or conviction to execute a trade. It also coincides with the few that control all the assets under management and generally do well over the years.

This is not to suggest that insider trading should be legalized, but rather that most perceptions are shaped by market price action.

No quick fix or widgets

When a portfolio manager claims his superpower is that he can learn and understand new things very quickly, he/she is more likely to be delusional. Of course, there is an elite group of professionals who are able to quickly synthesize information and take actions that have a subsequent market price impact. But their skills is not acquired overnight, and price observers merely reflect what they see on their screens. Also, sometimes even the sharpest minds get things wrong. How many times have pundits on Bloomberg/CNBC said something in the immediate aftermath of an important data release, only to retract it once the initial market reaction has reversed? “Oh no, it's actually dovish/hawkish if you actually look into the details.” 

The excuse that others knew something beforehand serves as a convenient narrative to excuse our own shortcomings. Some people just work smarter and harder.

How did we get to where we are today?

We spend a lot of time trying to understand why people do what they do, beginning with ourselves. Because we believe our mental thought processes are not especially unique or different from those of most market participants. We just try to be more aware of it, and it helps not having to manage money for clients or trade ourselves.

Let's briefly examine where we came from to see if there are any clues as to where we may be heading.

Towards the end of 2022, an overwhelming majority of market economists and strategists expected the US economy to enter a recession in the first half (H1) of 2023. The median 12-month estimated probability of a US recession by Wall Street analysts at the end of 2022 was around 65%. How did they arrive at these recession probability estimates when, broadly, we all have access to the same data?

How do we define the state of an economy?

In our view, historically, three factors have defined the state of most economists in analysts' reports: Economic growth (GDP), inflation (choose your measure), and the labor market (unemployment rate). Regardless of whether or not this constitutes an accurate measure of the true health of an economy, it's what most policymakers care about. The other key data releases are used to infer future trends and patterns in the aforementioned.

Why were Wall Street recession probability estimates so high?

We can't get into the minds of others, and it certainly does not help that almost all recession probabilities estimates are merely stated without a step-by-step method of how they are derived (as we like to do). It's painful to listen to the same ‘economists' or analysts justify their mistakes with reasons that were blatantly obvious even back then (fiscal expansion, excess savings, AI boom, etc), in such certain terms and with future assertions.

We would attribute the motivations for the exceptionally high recession probability estimates to the following key factors: i) The equity community was heavily influenced by the weak performance of the stock market in Q4 2023, led by declines in Big Tech stocks, and ii) Fixed-income investors took a bet on the US yield curve inversion which, depending on the choice of time horizons, has historically been a reliable lead indicator of a recession in 70-90% of occasions.

Ordinarily, we would not consider this a bad market call. It was the subsequent refusal to accept that they were wrong which is less excusable and continues to today.

Lower estimates of recession probabilities

By comparison, Goldman Sachs (GS) had estimated a 12-month recession probability of 25%. We estimated 20% by using a purely statistical method. Goldman Sachs Private Wealth (GSWM) team pushed the upper boundaries of their historical recession probability estimates with 45-55%. The simple truth is that there is no scientifically plausible way of forecasting an economic recession with a high degree of certainty when considering the entirety of the data and methodologies.

Hiding behind uncertainty and probabilities

The nature of probabilities is such that even a 99% certainty prediction can find refuge in the 1%. Nonetheless, it is still possible to appraise the quality of a forecast by following a stepwise process. And it is why we always publish our probability estimates with our full workings shown.

Market prices shaped their view, not economic data

In short, most Wall Street analysts and investors were led by the price action rather than the actual economic data at the time. The notion that the US economic data was weak in Q4 2022 is just plainly false. We have already drawn attention enough times, both at the time, and subsequently, to the few macroeconomists who stuck with the data in making their projections. Even if they proved to be wrong, our opinion would remain the same. The role of a good/credible analyst is to speak truth to power without undue influence from market prices. Otherwise, anyone could see that Big Tech stocks had been clobbered and that the yield curve was inverted.

The job of an investment professional is to stress test the analysis and make sound risk-reward judgments which align with investment mandates. Where necessary to argue the case against their analysts. And if necessary, fire/replace underperforming analysts. It sounds like a lot of work, but that's why most investment professionals are remunerated more than the analysts. Live and die by the sword. Period.

What did most fund managers do?

They divested out of good businesses with good earnings growth and high valuations, in favor of more defensive stocks and sectors with low valuations and growth potential. They extended duration and went overweight bonds in anticipation of an inevitable recession which would cause the Federal Reserve to rapidly cut interest rates. All very sensible in light of the consensus macro outlook.

Where did fund managers and analysts go wrong?

They took far too long to recognize they were wrong and reorient their views/positions. The March banking turmoil provided a new justification for existing positions. Similarly, with the debt ceiling impasse in Congress in May/June of this year. A long US Treasury positioning that would perform well in the event of a sharp economic (GDP) downturn shifted toward a less robust investment thesis about the relationship between long-term interest rates and inflation. There have been ample opportunities to correct course and reset.

Where do we stand today?

The CIOs of Amundi and BlackRock were recently in the media talking about signs of an increasing likelihood of a US recession. We believe that it is unlikely that they know something material that the rest of us can't see. It is more likely the same flawed investment thesis from the turn of the year being pushed forward in hope of materializing through the business cycle. Not that anyone has ever managed to predict the business cycle with any reasonable degree of certainty.

Risks well-balanced except US Treasury supply

At present, the risks to US inflation and GDP growth are finely balanced. An acceleration in US economic activity is, perhaps, an understated risk. The expected supply of US Treasuries from the central bank and central government is heavier than normal. Many tech startups are eagerly awaiting to do IPOs before the end of the year.

Those who got it right before are more likely to be right again

Goldman Sachs Research increased their 12-month rolling US recession probability estimates from 25% to 30% in March (2023), and have subsequently gradually reduced it to 15% throughout the year. i.e. In line with historical averages. The absolute levels and historical evolution of GS recession estimators indicate a consistent scientific approach which could potentially further decline if the economic data improves from hereon.

Let's not delude ourselves further, most of us won't rank in the top 10,000 most knowledgable people in the world on the US economy.

USD rates are the weak link

Taken together, the long USD interest rates thesis seems the weakest link, and the one that can continue to cause further pain. There are always unknown unknown factors, but that should not be the basis of a sound investment thesis. Unless, markets are priced to perfection such that unforeseeable risks are significantly underappreciated. However, we see no evidence that it is the case today.

Talking book in the media

Talking up your own book and positions is perfectly fine and acceptable. After all, who wants to take advice from someone who doesn't have any skin in the game? But, it must be presented as credible facts and reasons which are consistent with their actions. Or else, it smells like despair and desperation. And when the sharks smell blood, they're quick to pounce on a target.


It you're not convinced by our arguments, just ask yourselves how many Wall Street forecasters have continued to publish US recession probabilities throughout the year? The answer is none, except for a couple. The only time they do produce estimates is in response to media surveys. Which is indicative of analysts plucking a number out of thin air based on recent market price action, rather than a consistent ongoing process.

We'll also gladly run a real experiment to see how many market professionals can accurately assign a hawkish/dovish score on Fed communications. Either using past statements or newly written. Unfortunately, the only volunteers will be people who know what they're doing, or those who drafted the documents in a previous life.

Otherwise, for (sensible) long-term investors, investing a portion of their portfolios in US Treasury 10-year at 4.0% or 4.5% is the same. But, the narrative is dominate by those managing client assets that are redeemable within 3 months.

Have we sown the seeds of fear, self-doubt and paranoia in some minds? 😉

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Market outlook | Where are we and how we got here

What would you do if given exclusive access to Fed communications ahead of others?