In his latest memo (Sea Change, December 2022), Howard Marks argues that, after a multi-decade period of low and falling interest rates and frequent quantitative easing, “a significant portion of the money investors made resulted from the tailwind” that had been created. In this environment, according to Marks, fear of missing out (FOMO) has been the prevalent emotion, and, as is suggested by the title of his essay, we are now at the beginning of a long-term trend reversal. Rates are reverting to a more normal state and quantitative tightening is pulling out much of the liquidity that easing had pushed into markets. The time ahead would thus see a return to fundamentals, coming out of a long detour where technicals had been the driving force, in not so many words.
If technicals (market supply and demand) have shown a demand-side inflation formed by central intervention, there has emerged a growing gap between technicals and fundamentals (product supply and demand) — which is one way to define a bubble. According to Marks, or at least implied, the bubble is set to deflate, and assuming that a “sea change” is not a self-correcting blip but a lasting phenomenon, the reversal would give rise to a prolonged era in which risk assessment and valuation take on an element of renewed groundedness, where dips are not assertively bought, as has and would still be the case where FOMO dominates.
Especially where market sentiment is the subject, it is very difficult to make a forecast, or even to verify its correctness after the fact. Where central planning is involved — itself not devoid of sentiment— it is additionally difficult to know if or when the current mood will change, or possibly reverse. It is even speculative to call a bubble before a confirmatory pop.
In the meanwhile, however, one may try to look through certain past and present circumstances — cold and detached, if that is possible — and, without making a prediction, assess the atmosphere for qualities that catch attention. Marks does so in his FOMO atmosphere and monetary tailwind commentary, but stops short of what I believe are bigger and more universal matters, of which the noted characteristics are perhaps symptoms, rather than root causes.
One way, I think, to see the market profile of past years and decades — especially (but not exclusively) at times that led to notable corrections, such as the dot-com bubble to start the current century, and the mortgage-induced financial crisis that followed later in the decade — is an environment in which the discipline of marketing (more so than finance) dominated. This is a point of note, first off.
We’ve seen this promotional orientation, indirectly, in the exploding size of both private and public investment vehicles, and more directly in the growth of newsletters and blogs, financial and social media outlets, all giant billboard advertisements for clusters that have formed — not always around proven expertise or hard qualifications, not always with the interest of followers in mind. This brings us to a second point:
A side effect, perhaps, or possibly a cause of the above, has been an undue confidence in matters we don’t quite understand. The tone that led us to the aforementioned crises (dot-com and mortgages) are examples, not only for the general population but the leadership as well — the issuers and structurers and analyzers — in modern parlance, the influencers. The current period (in which both rates and quantitative easing were taken to extremes) has seen its share of small and larger cases… There will be more on this below, but first a speculation on potential causes.
As we’ve moved deeper and more universally into a state — in industry, in technology, in politics, in education, in more or less the bulk of our social interactions, including markets (which reflect these all) — centered around what we now call the “information” economy, our worldly stride, if such a thing exists, seems to prod along with a lazy and complacent rhythm. This is maybe based on easy access to most things, including money apparently, and particularly to what we believe is “knowledge.” But it’s not that, it’s merely information, while, on the other hand, knowledge sometimes turns more difficult to grasp with every new piece of information accessed. This is a less than ideal combination.
As was observed by Henry Kissinger in his book World Order, we do not think things through now, we merely look them up. And one might also add that we don’t take (or have) the time to process. In fairness to us all, the task would be daunting if we tried, given the increasingly connected but disparate pieces of a world that is perpetually changing. And yet, we’re confident in our proximity to “knowledge” — a confidence that maybe takes us further away.
One outcome (by way of evidence as well, in order to substantiate my theory) is the observed abundance of mistakes, especially of late, in nearly every segment. We see the broken objects everywhere we look. It may be as simple as a broken product or its launch (“move fast and break things”), but then as well a broken premise (e.g., crypto), a broken system (FTX), broken biology (COVID — before, during and after), a broken deal (Twitter, at first, and maybe still), a broken infrastructure or supply chain (as we’ve learned), a broken government (recalling the 6-week UK ministerial turnover) and policy (for instance, of the monetary sort, broken by all accounts, although the criticisms are, truth be told, broken). These isolated samples and so many others, I believe, are pushing to describe a widespread breakage, or disfunction that, remarkably enough, has not (yet?) had a depressing impact on financial markets broadly.
Now, misplaced confidence and promotional superficiality may have existed since the dawn of time, at least in ebbs and flows. Are these qualities correlated with economic and financial swings? Perhaps. In fact, no doubt. In any case, loose money doesn’t hurt. But still it is a matter of degree, of composition, and of context. As depicted. It isn’t difficult to argue that we are now at new extremes, shadowing the extremes of monetary intervention that took place. And were the pattern to be plotted, we might see a steady rise from which a surge has exponentially followed: Gradually and then of a sudden, as Hemingway’s expression sort of goes (in reference to bankruptcy).
But back to investment, the underlying subject of this essay. According to Nassim Nicholas Taleb, a “Black Swan” is an event that is widespread, massively consequential, and beyond what may be normally anticipated. In an environment of deep global complexity, spreading interconnectivity, and an accelerating pace of change; in an environment prone to turbulence and unintended consequences — as would often be triggered within a dynamic network system — a “sea change” that takes us back to thoughtfulness and fundamentals, as envisioned by Howard Marks, may be the optimistic scenario.
At the other end, the downside, where sloppiness and breakage happen with great regularity in the environment described, Black Swan risk may be on the rise. Its egg may have already hatched, and FTX may only be a glimpse at the disheveled bird whose little feathered head sticks out.