In the late 1970s, Saturday Night Live aired a sketch featuring Kirk Douglas reprising his role as Spartacus, entitled “What If”. In the sketch it is asked: “What if Spartacus has a Piper Cub?” The sketch features Spartacus and a modern day pilot flying over ancient Rome.
Meanwhile, learned men, on the ground, try to explain this phenomenon. Meanwhile, encouraged by the pilot, Spartacus begins dropping items from the plane on the bewildered Romans who, having never seen a flying machine, consult the writings of scribes which discuss “omens” in the sky.
At present, I believe the markets and, possibly, the economy are in a big “What If” sketch. Having never seen policy renormalization, firsthand, and having been taught what has happened in the past and past correlations, but not necessarily why things happened and why phenomena has correlated (positively or inversely), many of today’s market strategists are reacting like the Romans in the sketch, in my opinion.
Remembering the past to inform the future
It is because this lack of experience and limited understanding of monetary policy tightening that we get crazy strategy opinions such as:
Because risk assets have done well when the Fed has tightened in the past, Fed tightening will result in risk assets performing well.
Or:
Because long rates typically climb when the Fed begins tightening policy, policy tightening results in rising rates across the yield curve.
These beliefs ignore two facts, yes facts. In the past, risk assets have done well when the Fed began tightening because the economy was ripping along and it took a while before monetary policy was sufficiently tight to normalize conditions. Risk assets were not performing well because of Fed tightening.
Frustrating the market
The same is true of the yield curve. Typically when the Fed begins tightening, inflation pressures are rising. As such, long-term rates are rising. The Fed then begins tightening to blunt inflation pressures. However, it takes time and often numerous Fed policy tightening moves to curb the extension of credit to businesses and individuals.
Until Fed policy becomes, at least, neutral, there is a period of time where both short-term and long-term rates rise. However, long-term rates are not rising because of Fed tightening. In a way, they are rising in spite of Fed tightening.
I find it frustrating that educated market professionals are falling prey to the Post hoc ergo propter hoc fallacy. This is a logical fallacy which states: Since event B followed event A, event B must have been caused by event A. The fallacy lies in a conclusion based solely on the order in which events occurred, rather than taking into account other factors potentially responsible for the result.
Determining causality solely in order of events is rather dull-witted, in my opinion. Understanding the dangers of falling into the post hoc ergo propter hoc trap is so important, it is discussed in 100 level economics courses. That there are strategies and market outlooks based largely on post hoc ergo propter hoc frightens me. It should frighten you, as well.
Financial advisors are required to inform clients that past performance is not an indication of future results. Yet I read strategy report after strategy report which uses a return to past conditions and post hoc correlations as their bases. Surely strategists are more intelligent than that. I believe they are, but are often pressured by superiors and, perhaps, their audience to publish outlooks and strategies which fit preferred narratives. To them I say: Good luck
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Thomas Byrne
