Breadth Thrusts & Bread Crusts: The World Is An Uncertain Place

JC Parets
July 21, 2022

From the desk of Willie Delwiche.

The world is an uncertain place. 

But that doesn’t make it altogether random. Trends persist – right up until the point that they don’t. If we’re going to move beyond irrefutable narratives and successfully navigate reality, we need to develop feedback mechanisms that can keep us on the right path (and get us back on the path when we stumble into the weeds). 

Operating in the world as it is and not as we would like it to be requires an ability to test viewpoints, an awareness that sometimes the ground shifts beneath our feet and a willingness to consider scenarios from both directions.  

1. Develop a hypothesis and test it. The key here is not whether your initial view is right or wrong, but knowing this information as soon as possible. How do we know if things are playing out as expected? What evidence would prove we were wrong and need to adapt our views? This year, we have seen plenty of evidence that stocks are in a bear market. That trend will persist until it doesn’t. 

We’ve put together a checklist that we are leaning on to provide evidence that the market environment is changing. As more indicators suggest that a new bull market is being born (currently we are just at 1 out of 5 – but that’s better than the 0 out of 5 that we had coming into this week), our expectations for the market will change. In addition to being uncertain, the world is a dynamic place and we need to be willing to adapt. As Keynes once wrote, “when my information changes, I alter my conclusions.”

2. Is the paradigm intact or has it shifted? If we are relying on evidence to make decisions, we are necessarily looking at the past (when thinking about the future, it’s conjecture not evidence). We base our decisions on the assumption that relationships of the past are likely to hold in the future. Being too quick to declare an indicator broken or irrelevant or that “this time is different” takes us out of reality and into our narratives. 

At the same time, shifts do periodically occur and we need to be willing to move beyond our recency biases if we are going to be successful. Investors conditioned to stocks and bonds moving in opposite directions (and thus tempering volatility in balanced portfolios) were caught off guard in the first half of this year as both stocks and bonds moved lower in back-to-back quarters. In this case, a changing inflation regime upset the apple cart. The question now is whether that was a short-lived event or a more durable shift.

3. Work forward and backward. We can lay out a scenario in which a certain asset could do well. That’s the relatively easy part. The harder and often overlooked question is to consider the scenario that was laid out and what the best course of action would be in that environment. 

The asset you started out considering may not be the one you actually want to hold – even if its best case scenario came about. This came up in conversation earlier this week. We were describing conditions under which a certain asset would do well. But in the course of the conversation, someone pointed out that if the situation we described were to take place, that asset would not top the list of compelling opportunities. A best case for one asset may prove to be an even better case for another asset. But if we only think about things in one direction, we won’t see it. 

We don’t have the gift of foresight and we don’t know what the future will bring. But that’s no excuse for remaining locked inside our narratives and keeping our eyes closed to the reality the market is presenting. We adapt and adjust and survive by taking what the market gives, however unexpected it may have been. 

 

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