Mind Games

It’s a broken record, yes, but it’s also a tautology: There’s a lot of uncertainty about the future right now.

We (market participants) have a manifestly ridiculous tendency to declare ourselves unsure about what the next chapter of the macro story has in store for us, and then pretend as though we’ve said something profound.

Just about every piece of macro research you care to read these days (not to mention every rumination emanating from grossly overpaid executives and chief economists employed by the world’s foremost multilateral institutions), suggests the current environment admits of more uncertainty than any macro backdrop they’ve ever experienced in their professional careers.

Of course, that’s not true. In fact, analysts, CIOs, CFOs and economists were staring down the most uncertainty humanity has witnessed in modern times in December of 2019 — they just didn’t know it yet.

That begs the question, and lays bare the tautological nature of our predisposition to traffic in nonsense: Since we can’t know the future, we can never know anything about the outlook. We can’t know what we don’t know.

We can, however, make somewhat educated guesses about the relative level of uncertainty going forward after periods when things have gone horribly awry. That’s why, during our darkest hours, we humans have a tendency to throw up our hands, look skyward and shout to the gods: “Well, on the bright side, it can’t possibly get any worse!” (Then it starts raining on us.)

Where this gets confusing for individual market participants is in the collective tendency for asset prices to pull forward future outcomes. We know stocks are forward-looking. So even if we come to the conclusion that things are unlikely to get any worse given how bad things have been lately, we worry that stocks have already “priced it in.” Global equity funds took in another $14.6 billion last week, bringing the 2021 total to $427 billion (figure below), for example. That’s a lot of “pricing in.”

It doesn’t help that we, as a species, tend to fear statistically unlikely events more so than we do relatively common pitfalls when the former are flashy and the latter mundane. You’re far more likely to die from eating too much junk food than you are from an al-Qaeda attack, for example. But nobody avoids buying frozen vegetables because they’re scared of getting too close to the ice cream sandwiches in the freezer aisle.

If, against the odds, we actually experience a headline-grabbing catastrophe (in this case a pandemic), that irrational tendency is easier for us to rationalize, and thereby becomes immeasurably more acute.

Where does the above leave market participants now? Well, if you put it together, it produces precisely the kind of macro commentary you read and hear every, single day.

The backdrop is exceptionally uncertain. Maybe the worst is over, but even if it is, look at valuations! And earnings expectations have already rebounded dramatically. If an ~80% rally in equities from the lows doesn’t count as “priced in,” then what does?

Maybe modern science does have a decent handle on the situation. It does seem likely that Moderna and Pfizer will be able to stay close enough on the virus’s heels to stave off another global meltdown. But look at India! Couldn’t the variant spreading there evade the vaccines?

More generally: You told me the odds of getting struck by lightning were infinitesimal last year, and here we are a year later, charred lightning-strike survivors. Maybe I don’t believe you anymore!

This is the psychological tug-of-war going on in the minds of every macro strategist, C-Suite occupant, equity analyst and economist the world over.

After reminding market participants that US stocks tend to post only modest gains after blockbuster earnings growth (like that expected over the next few quarters), Ned Davis offered some caveats. “Of course, for now, these high earnings are still estimated or rumored,” the firm noted. “Yet, because the estimates have been out for a while and are so high, and the S&P 500 has already had the largest one-year advance from a low since WW2, [we’ve] changed the rule ‘buy the rumor, sell the news,’ to ‘hold on the rumor, sell on the news.'”

“This year, [Sell in May and go away] may be particularly relevant,” Bloomberg’s Eddie van der Walt said Monday, in a short piece called “Scope for a May Unwind in Stocks Is Substantial.” “Stocks may be ripe for profit-taking [and] expectations for earnings boosts from economic reopenings might be overcooked,” he ventured. “And then there’s the tail risk that rising inflation will force central banks to taper debt purchases early, yanking the floor from under bonds and tech stocks alike.”

SocGen’s Andrew Lapthorne weighed in with some characteristically cautious commentary. “Earnings momentum remains strong in the US, with the S&P 500 and the Russell 2000 seeing the best of the upgrades and the combination of last year’s weaker earnings dropping out of the frame means the 12-month forward EPS consensus is some 12% higher YTD, roughly equivalent to the overall S&P 500 performance,” he said, before reminding folks (again) that “this still leaves the index” trading more than 21X end-2022 earnings, “a long way from being ‘cheap.'”

What can I say? There’s a lot of uncertainty about the future right now.