Glass Half-Full

If you’re the pessimistic type when it comes to markets, 2021 wasn’t your year.

Or at least not at the equity index level.

There was plenty of churn beneath the surface. Indeed, the ebb and flow of the re-opening story and the hideous metamorphosis that turned a risk-on reflation fairy tale into a risk-off inflation nightmare engendered harrowing factor swings, thematic dramatics, sudden selloffs, painful de-ratings and a marked deterioration in breadth.

But you wouldn’t know about any of that if all you looked at were the benchmarks. The fireworks played out under the hood. And why look under there when the bird’s-eye view is so pleasant to behold? Coming into the year’s final week, the S&P had logged nearly six-dozen record highs (figure below).

At 68, the index was just nine shy of 1995’s all-time record for… well, for all-time records.

One could make a laundry list of concerns for 2022, but the problem with posing the sarcastic “What could go wrong?” question is just that the answer is always “Anything and everything.”

The vast majority of market participants are completely oblivious to that simple observation. Year-ahead outlook pieces from Wall Street invariably detail why the next 12 months “should be” more or less favorable for a given asset class. A year later, with the benefit of hindsight, everyone (including the analysts and strategists who penned the outlooks) talks about what they got right and what they got wrong. Rarely does anyone acknowledge that the real spanner in the works wasn’t an erroneous model input or some wildly misguided set of assumptions. Critics of Wall Street strategy pieces don’t like to admit this, but generally speaking, they’re almost always eminently plausible. Everyone is working with the same information and the same models, and nobody has the crystal ball necessary to forecast the events that will ultimately end up dictating the direction of asset prices in a given year. If you had a crystal ball, you wouldn’t need to write a tome if you were inexplicably inclined to share what you gleaned from Pythia. You could just write a few summary bullet points. Absent superhuman prescience, we produce novella-length research that more or less posits stability with an error band to account for modest deviations from business as usual. And there’s nothing wrong with that. It’s the best we can do.

It feels obligatory, so I’ll highlight the tail risk list from the December vintage of BofA’s Global Fund Manager survey (below).

Everyone trades the last crisis. If there is a bear market in 2022, the odds are at least as good that it’ll be triggered by something not on that list as the odds that one of those well-known risks undercuts sentiment.

In the aftermath of a crisis (or following a particularly stupendous year for stocks), we often disingenuously pretend that everyone who got it wrong (so, pretty much everybody) was oblivious to the factors that ended up mattering the most. But that’s almost never true. It wasn’t that Michael Burry and a handful of “weirdos” were the only people on the planet who understood the perils embedded in subprime securitizations. Rather, it was that predicting precisely when the Jenga tower would collapse was decidedly difficult, even when armed with D-days for en masse ARM resets. Everyone knew another pandemic was just a matter of time, but incorporating that into a year-ahead outlook is impossible for obvious reasons. Everyone understood that unprecedented fiscal and monetary stimulus was bullish for risk assets and conducive to inflation, and most people also knew COVID would probably mutate with the potential to evade the vaccines. But knowing all of that didn’t make it any easier to predict the S&P would log 68 record highs even as US CPI soared to almost 7% and that those outcomes would play out despite (and, in some ways, because of) the persistence of the pandemic and new virus variants.

Each and every autumn, scores of highly intelligent people avail themselves not just of the best data around, but also of access to experts in any field that might be relevant to forecasting asset prices (e.g., former trade officials during the Trump years and medical doctors of various sorts headed into 2021). Then, they get together and take a stab at penning a market-focused unified theory of everything for the coming year.

It’s almost always an exercise in futility. Not because the people involved are somehow bereft and not because any of the assumptions were misguided given the distribution of probabilities associated with known risks. Everyone perpetually gets it wrong because the task is inherently impossible. If the sheer number of relevant variables isn’t enough to render the entire endeavor so ludicrously ambitious as to be a total waste of time, the starring role of human behavior surely is.

Our collective failure to recognize the futility of forecasting outcomes in any given year isn’t confined to asset prices. We’re not very good at acknowledging it in any context, really.

I’m not sure about anyone else, but some of the worst years of my life started out with objectively favorable setups. One particularly poignant example was 2016. On January 1 of that fateful year, I had just cashed a very large bonus check (at the end of December, like an imbecile, instead of waiting for the calendar to flip to a new tax year). I was settling into an island villa for what I thought would be a kind of sojourn, defined by light work for a few hours on sunny mornings with the balance of my days spent shopping, drinking and generally adding to a personal legend which was (and remains) infinitely more grandiose in my own imagination than it is in reality. 11 months later, I was nearly dead.

That turn of events more than offset the new chapter I actually did manage to add to my life’s legend. As late as February of 2016, I had every reason to believe that year would be defined by outstanding personal performance, although if I were an asset, PMs would probably avoid me, citing a spotty Sharpe ratio. Instead, I suffered the second worst personal bear market of my life.

What then, are we to make of voluminous outlook pieces implicitly offering a unified theory of everything in the service of predicting the trajectory and destination for equity prices 12 months on from a year that featured 68 record highs by Christmas in the midst of a still-raging pandemic, the highest US inflation in four decades and a shellshocked Federal Reserve asking “What would Paul do?”

The truth is, we can’t make anything of them. Like our own personal outlooks for the year ahead, Wall Street outlook pieces incorporate all available information and strategists assign (mostly subjective) probabilities to known risks. Most of the time, stocks go up. And, to the chagrin of one well-known former employer, I don’t nearly die in most years.

Seen in that light, it makes sense to be an optimist — a (rocks) glass half-full kind of guy, even if my glass will forever be empty, lest my next 2016 be my last.

In what counted as his own year-ahead outlook piece, SocGen’s Albert Edwards explained why he generally takes the other side of the argument. “It stems from my nervousness whenever I see a glass half-full after I had one smashed in my face when I was drinking in a London pub aged a mere 15,” Edwards wrote.

“Admittedly, inviting the man who was threatening me to ‘Go ahead and see what happens,’ perhaps wasn’t the wisest strategy,” Albert added. “But I was young and invincible.”

So was I. And so is the S&P.