Forecasting winter is for lemmings

Be skeptical when experts or the crowd point too strongly in any direction.

Forecasting winter is for lemmings
Photo by Aaron Burden / Unsplash

With the S&P 500 down 10% in the last month, crypto collapsing 40% in the last 90 days, and the latest U.S. inflation readings coming in at over 7% it's all too easy to run for the exits and hunker down for winter. Before you take either expert opinion or the wisdom of the crowd too seriously, just remember that no one knows what's going to happen next!

Here's a nice reminder of the historical efficacy of expert forecasts. What do Warren Buffett, Elvis Presley, and Michael Lewis all have in common?

One of the biggest headwinds for markets will surely be the fear of substantive changes to monetary policies and therefore interest rates. We learn in Finance 101 that the value of an asset is the discounted stream of future cash flows it generates, and the rate at which we discount matters. e.g. the higher the rate, the less we value future cash flows.

It sure does look like the Fed has to raise rates and maybe this means that the extreme expansionary policies since...Greenspan?...are nearing an end. I wouldn't count on it. If we think of the constraints of everyone involved, it's hard to believe that any Fed Chair or politician wants to preside over the reversal of decades of an expansionary money and credit cycle. Easy money and credit means lots of jobs, corporate profits, soaring asset prices, and happy voters. I just don't think anyone has the stomach for taking away the punch bowl. But...they all have to pretend they do and that means starting down the path of nudging rates higher.

So where does that leave us? The Fed's unprecedented COVID-related bond purchase program (unprecedented since...QE...that...never...ended) is going to wind down. Until the next crisis. This means that the rate of new money created might slow down. On top of this, markets seem to expect three or four interest rate hikes this year. Ceteris paribus, this is not so bueno for asset prices because loads of new money and cheap credit tend to inflate prices.

Tightening monetary policies aren't the only threat to perpetually booming markets. After the $1.9 trillion American Rescue Plan it doesn't seem Congress works anymore and would have a tough time sending trillions of dollars more into the economy. Russia seems obsessed with attacking Ukraine despite denying it every day since the troop buildup started months ago. China and the U.S. are having a tougher time than usual getting along. And the list of potential catalysts for market chaos goes on. But there's always a list and we can always be pessimistic.

And there's always a flip side. How much of the -40% of crypto returns is baked into future expectations? Meaning, what if the next inflation report comes in lower than expected? What if Omicron ends the COVID chaos and supply chains whip back to normal sooner? What if Putin actually doesn't want to terrorize Ukraine and ends up dismantling the invasion force? OK, maybe the last one isn't so likely, but you get the point.

In particular, the Fed will be looking for any reason not to end the party and so we're getting this weird buildup of negativity driving prices lower mixed with a tense hope to dive right back into markets as soon as anything changes.  

The moral of this particular story is that markets could go either way and we'll just have to wait to see what happens. Crypto tends to be the canary in the coal mine of risky assets, which also means it can be the first to recover sharply when things reverse. Is a 40% drop already deep enough a discount to wade back in? I have no idea and I'm way too biased anyway to make that call. The one certainty I can leave you with is that the more confidently you hear someone speak about uncertainty, the more confidently you can discount everything they're saying!  


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