The arc of history, and markets

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Grand market narratives

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

If you doubt that anyone really falls for The Great Historical Algorithm that predicts The Very Big Thing That is About To Happen, I suggest you read Francis Fukuyama’s review of Neil Howe’s “The Fourth Turning Is Here” and Peter Turchin’s “End Times”, in the New York Times. Turchin’s book is based on something called “cliodynamics”: in Fukuyama’s words, “a variety of Big Data analysis that makes predictions by applying mathematical models to a huge database of prior historical crises stretching back several millennia.” So described, the method is indistinguishable from the “psychohistory” of Asimov’s mid-century imagination.

On Wall Street, some grand theories and historic narratives come from investors who have made a lot of money, which lends them credibility. It is tempting, for example, to take George Soros’ theory of reflexivity or Ray Dalio’s talk about five big forces of history seriously as predictive frameworks. But good investors are no better than the rest of us at seeing the future; their skill is acute grasp of the present. Whenever anyone starts in 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 ahead as we can. To the extent we think economies and markets are susceptible to analysis, it is natural that we should try to anticipate not just cyclical shifts but regime changes. The latest to give it a go are Jim Reid, Henry Allen and Galina Pozdnyakova of Deutsche Bank, who released the third part of their long-term asset return study yesterday, under the title “The History (and Future) of Recessions”. The study is long and crunchy, and contains lots of useful charts and tables about the frequency, depth and duration of recessions across developed markets going back decades and even centuries.

The forward-facing argument of the piece is that the post-1982 period of falling rates, low inflation and long economic expansions is historically anomalous and probably over. That period was characterised by not just deepening globalisation but by activist fiscal and monetary policy that softened economic downturns and led to a big build-up of debt.

Now, however,

[T]his approach is running up against increasing limits. In particular, public and private debt burdens have risen to very high levels, which is limiting our room for manoeuvre in the future. Alongside that, real yields have climbed sharply in the last couple of years, so the cost of additional debt is going up. And with [ageing demographics and deglobalisation] continuing to exert upward pressure on inflation, the coming years could well bring more volatile swings in interest rates, and hence more volatile business cycles. This is likely to impose 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 argue. Indeed there is a strong streak of market fundamentalism running through the report, suggesting that a “natural” business 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 reason for the long business cycles of recent decades is sheer luck. In the past, many recessions have resulted from disasters, wars, pandemics, and other endogenous shocks, and “the fact we’ve only seen four US recessions over the last four decades is very unusual, and one that’s unlikely to repeat without an enormous amount of good luck”.

Longtime readers of Unhedged will recognise another important feature of this thesis: a lot of people agree with it, or at least hold views closely related to it. Among people with the gall to predict economic regime changes, it is close to being the consensus. It shares a lot with Charles Goodhart and Manoj Pradhan’s demographic argument about interest rates. It is a milder version of Nouriel Roubini’s prediction of a stagflationary debt crisis. It sounds a lot like the house view of the BlackRock Investment Institute. Michael Hartnett at Bank of America has argued for a similar set of outcomes. The list goes on.

The adolescent in me responds to the popularity of this forecast by doubting it. I just don’t think people tend to get big calls like this right, and the fact that so many people are gravitating to this particular call makes me wonder if the appeal of the story is its tidiness rather than its rigour. My attitude does not deserve to be called a counterargument, however, and there is a lot of solid work in the Reid report and its predecessors.

I do, however, suspect that part of what drives the consensus view of regime change is terribly simple. It is hard to look at a long-term chart of US interest rates and not think we are about to have a regime change in which rates rise. Here’s Deutsche Bank’s version of the chart:

Line go up 1950-1982; line go down to zero bound 1982-2020; now line must go up! That’s not an argument, either, but at least it’s not science fiction.

One good read

Capitulation comes to the San Francisco office market.