The Fog of Markets

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“The year 1915 was fated to be disastrous to the cause of the Allies and to the whole world. By the mistakes of this year the opportunity was lost of confining the conflagration within limits which though enormous were not uncontrolled. Thereafter the fire roared on till it burnt itself out. Thereafter events passed very largely outside the scope of conscious choice. Governments and individuals conformed to the rhythm of the tragedy, and swayed and staggered forward in helpless violence, slaughtering and squandering on ever-increasing scales, till injuries were wrought to the structure of human society which a century will not efface, and which may conceivably prove fatal to the present civilization.”

Winston S. Churchill – The World Crisis: 1915

After reading that quote several times, it remains shocking that the politicians and individuals of that era unconsciously “conformed to the rhythm of the tragedy.” The paragraph describes the mass mindset of World War I when it was still in its infancy. War-time narratives, nationalism, destruction and the tremendous loss of life led most people to quickly accept and acclimate to an event that was beyond atrocious. Amazingly, less than a year before the period Churchill discussed, the same people would have thought that acceptance of such a calamity would be beyond comprehension.

Wars and markets are obviously on two different planes. The purpose of this article is not to compare the evils of war to financial markets. That said, quick acceptance of abnormal circumstances, as Churchill described, is a trait that we all possess. The implausible, the absurd and the extraordinary can quickly become the norm. Assumingly, this coping mechanism enables us to retain our sanity when events are far from normal.

The fog of markets

The unabated march upwards in stock prices occurring over the last eight years has had a mind-numbing effect on investors. The relentless grind higher is backed by weak fundamentals providing little to no justification for elevated prices. Indeed, if there was no justification for such valuations during the economically superior timeframe of the late 1990s, how does coherent logic rationalize current circumstances? For example, feeble economic growth, stagnating corporate earnings, unstable levels of debt, income and wage inequality and a host of other economic ills typically do not command a steep premium and so little regard for risk.

This time, however, is different, and investors have turned a blind eye to such inconvenient facts and instead bank on a rosy future. Thus far, they have been rewarded. But as is so often the case with superficial gratification, the rewards are very likely to prove fleeting and what’s left behind will be deep regret.

Despite our education and experience that teach the many aspects of the discipline of prudent investing, investors are still prone to become victims of the philosophy and psychology of the world around them. These lapses, where popular opinion-based investment decisions crowd out the sound logic and rationale for prudence and discipline, eventually carry a destructively high price.

Investors, actually the entire population, have become mesmerized by the system as altered and put forth by the central bankers. We have somehow become accustomed to believing that debt-enabling low interest rates make even more debt acceptable. Ever higher valuations of assets are justifiable on the false premise of a manufactured and artificial economic construct.

From Winston Churchill, we move to John Hussman of Hussman Funds. The following quote discusses the mindset permeating the stock market:

Investors and even financial professionals rarely recognize asset bubbles while they are in progress. As the price of a financial asset rises, investors have an increasing tendency to use the past returns and the past trajectory of the asset as the basis for their future return expectations. The more extended the advance, and the higher valuations become, the more stable and promising the investment can appear to be, when judged through the rear-view mirror. That extrapolation was at the root of the tech bubble that ended in 2000, and the mortgage bubble that ended in 2007. It is also at the root of the very mature bubble that has again been established today.

John Hussman’s Weekly Market Commentary February 6, 2017