Prelude To A Kiss

The Credit Strategist - December 2022

We know so much yet we know so little.  We know that the Fed is going to raise interest rates by 50 basis points in December, bringing the benchmark Federal Funds rate to 4.25-4.50%.  But that’s the easy part because that’s pretty much all we know.  After that, despite reams of data, nobody knows with certainty what will happen to the economy and markets.  We can only talk in probabilities and right now markets are acting contrary to those probabilities.   Forecasting those probabilities is especially difficult in a world that is more interconnected than ever by trade, technology, currency, monetary, supply chain, and psychological flows.  None of these connections are unidirectional; all of them contain their own complexities, dislocations, conflicts and crosscurrents.  Forecasting in such an environment is a matter of separating the signal from the noise and avoiding the all-too human trap of confusing what one wants to happen with what one objectively thinks will happen. 

One of the traps many investors fall into is believing that markets are always right.  They are taught to believe in the so-called “wisdom of crowds.”  This belief is profoundly dangerous.  Look no further than who we elect to political office.  The crowd rarely gets things right.  Mass delusion is a widespread human phenomenon to which markets are especially vulnerable.  Prices set by markets are invariably wrong.  There is never a true price for any security, just an estimate of what the crowd decides it’s worth at any particular point in time.  But that mispricing makes markets and creates opportunities to profit from investing in securities.  Investors are counting on the price of securities being wrong when they buy them.  And the question investors should be constantly asking is how mispriced their investments are.  For years stock prices were grossly inflated by factors unrelated to the fundamentals of their underlying companies.  Investors who didn’t question those prices are now feeling the pain of seeing those stocks lose as much as 90% or more of their value.  The market is always wrong and so is the crowd.  Learning that lesson is one key to becoming a successful investor.