Burn The Playbook

Congratulations. You’ve borne witness to macro history.

I won’t trouble readers with the usual semantics. Suffice to say my obsessive commitment to precision sometimes compels me to note that technically, the world makes history every, single day. In that sense, proclamations about “history in the making” are everywhere and always applicable.

Over the past two years, though, market participants have witnessed a dramatic shift in the macro landscape worthy of a dedicated chapter in economics textbooks. Depending on how things unfold, we might’ve just lived through the end of The Great Moderation. I’ve suggested 2022 marked the “dawn of The Great Immoderation,” a contention that rests in part on the notion that macro volatility likely won’t subside such that it’s possible to declare the past two years an anomaly. Indeed, I’ve repeatedly suggested that The Great Moderation was in fact the anomaly, and that we’re now reverting to humanity’s natural state, defined by volatility in all spheres. Our conception of “normal,” I’ve cautioned, is a product of recency bias.

That has all manner of implications for geopolitics and society in general. I’ve explored them (the implications) at length across dozens of articles in addition to those linked above. From a “pure markets” and “pure macro” perspective (I don’t think it’s possible to conceptualize of markets and the macro in a vacuum, where that means without reference to society and geopolitics, but I have to pretend occasionally), the implication is that investors, traders and economists are left to stare at a kind of vice versa version of the past dozen years.

I’ve used that characterization before, but I wanted to rekindle it Monday in conjunction with updated versions of two Goldman charts which illustrate the point.

“The era of very cheap money and QE resulted in a period during which price rises in the real economy were very limited (for example in wages, nominal GDP growth, CPI inflation), while inflation in financial assets was very high, particularly in real terms,” the bank’s Peter Oppenheimer wrote. “The best financial assets were the longest duration.”

The figure (above) illustrates the regime that existed from January 2009 through February 2020, on the eve of the pandemic.

Fast forward two years, and the world is well and truly upside down.

The figure (below) shows YTD performance across the same assets and also the evolution of real-economy prices in 2022.

Keep in mind: The scales are different and the first figure represents 11 years, while the second depicts outcomes observed over less than 11 months. That makes side-by-side comparisons a bit awkward, but the overarching point, as expounded by Oppenheimer, is just that “inflation in the real world has been much higher than in financial assets which achieved negative nominal and real returns.” Commodities performed best, while long-duration assets were positively (or negatively, depending on how you want to phrase it) beset.

If this continues for any appreciable length of time (i.e., if it isn’t “transitory”), then a meaningful percentage of concerned parties, both on Wall Street and in the economics profession, will lose their frame of reference. That’s especially true when you consider that although the post-financial crisis era makes for the most compelling juxtaposition given the effects of NIRP, ZIRP, LSAP and forward guidance, the ascendancy of the simple 60:40 portfolio (and the underlying correlation assumptions) dates back further, and the trend towards subdued macro volatility and relatively benign inflation outcomes even further than that.

Regular readers have heard “epochal” and “sea change” from me more times than they probably care to remember. But despite the pervasiveness and ubiquity of sundry “sea change” narratives, one can sense a reluctance on the part of many (most, even) investors to accept the possibility that we really aren’t in Kansas anymore. And that going forward, the old playbook simply won’t apply.


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6 thoughts on “Burn The Playbook

  1. I align with your view that we’re seeing the dawn of a new day, The Great Immoderation, and I believe The Great Moderation was an anomaly. And once we get through what, I believe, will be a recession early in ’23, life will be more like I recall in a previous life – a little less predictable, and requiring a bit more stomach.

    I’m also wondering what the world will look like from a political standpoint. My guess is that it will be more free-wheeling and contentious.


  2. Other than the self-inflicted energy crisis in Europe, I would say much of the supply chain disruption has to do with excessive demand created by QE and helicopter money fiscal policy that the “just in time” long distance (e.g.) supply chain simply cannot handle. I think a proper recession that reduces the excess demand (but hopefully not killing supply too much) will bring back some balance.

    With the excessive orders from 2021 and 2022 making its way thru the logistic, I think 2023 will be year of excess inventory and write down.

    i.e. Would anyone ever thought that Nvidia would have excessive inventory to clear?

  3. We’re not in Kansas anymore, indeed….but I would assert we crossed the border into Oz-land long ago – at least as far back as the Dot-Com era, and perhaps 1987. But, I’d also suggest that the willingness of governments to forget sensible economics in favor of populist politics – and try to fight recession and the inexorable effects of demographics and ever higher debt loads by kicking the cans still further down the road with new rounds of ZIRP, Helicopter Money and their ilk – should not be underestimated.

  4. The past 2.5 years have been the most interesting, intriguing, exciting period for stockpicking since, well, March 2009 and the few years that followed. Has been for me, anyway.

    Exiting the straitjacket of US large cap growth has opened up whole worlds of good opportunities in a diverse set of names.

    Granted, outperforming is more fun on the upside, but it feels to me that we’re getting close to that chance – albeit with some renewed downside to be endured first, in my opinion.

    The fixed income side has been pretty uniformly miserable, but it feels that we’re only a few dozen bps and a few months from some nice opportunities there.

    The old playbook was getting stagnant, suffocating, stultifying. No playbook is better.

  5. I think YTD conditions persist as long as inflation is high and rates are rising, so maybe into mid 2023 the inflation, value, rate exposures can keep working.

    When inflation is declining and rates not rising, those will be different conditions. Need to start figuring out what will work then. It may be early, but markets will rotate to front-run economy.

    When inflation is low and rates are falling, those will be different conditions yet.

  6. The “playbook” contains mechanical relationships and reactive behavior. It’s the latter area where I expect to see change. To me, the important thing to ever get a handle on is an inflection point. Statistical models can’t find them. You have to wait until they happen. There was a book published back in the day by French mathematician Rene Thom, called Catastrophe Theory. I wrote a few papers based on this work but in general, the ideas Thom postulated (he would say proved) just never seemed to catch on. Too bad, because this approach could spot inflection points in advance.

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