Climbing the Wall of Worry
I hear all these problems. But history says the greatest bull markets climb the wall of worry. There’s always these things you can worry about to keep people out (of the market). When no one has any worries, when there’s no clouds on the horizon, that’s when I want to get out of the market.”
Jeremy Siegel, famous Wharton School of Business professor
The truth is that investing is always worrisome. If it weren’t, it would be really stupid, because there would be no risk premium, prices would already be high, and there would be no opportunity to make money.”
Sam Ro, Business Insider
The old market adage “Climbing a Wall of Worry” refers to the fact that some of the best bull markets occur in the face of uncertainty and worry about the economy. Currently, there seems to be no end to the number of possible scenarios that could derail this aging bull market. Recently Fed Chair Janet Yellen renewed vows to raise interest rates not once but twice before the end of the year, despite solid evidence of a slowing economy. Earnings have been lackluster and recent jobs numbers were terrible, which seem to suggest that the Fed will hold off at least in the short-term. Meanwhile, fears continue to grow that the U.K. will opt to exit the European Union which has been appropriately named “Brexit.” In Asia there is concern of economic slowdown, and also the chance that China will eventually choose to devalue its currency.
Given all of these concerns shouldn’t the market be falling?
As it turns out we are once again threatening to breakout of the long sideways markets to new highs in the S&P500:
Why the disconnect?
As it turns out unlike economic data, the market has a strong tendency to look forward instead of backward. While this has been demonstrated many times in academic research, one of the more interesting analyses comes from prediction wizard Nate Silver of the blog “FiveThirtyEight.” First Nate compares market performance to future GDP changes using regression:
For those that are not used to statistical plots, the upward sloping line means that the recent S&P500 6-month change has a positive relationship with future GDP growth in the next 6-months. In contrast, while not shown, if you tried to predict the stock market using GDP you would end up with a flat line- indicating no relationship or predictive value. Markets forecast future economic growth and not vice versa so the next time that you hear complaints about a slow economy, remember that this does NOT mean that the stock market will be weak in the future. What was interesting was that Nate Silver found that the forecasting power of the stock market contained information that economists’ forecasts were lacking. Perhaps the most shocking finding in his analysis was that GDP growth was strongest when the market and the economists disagreed:
As you can see in the table above, actual GDP was nearly double the consensus forecast when the S&P500 was strong over the last 6 months and economists were bearish. What that seems to imply in the current market conditions is that economic growth may actually surprise to the upside in the coming final six months of the year. While many portfolio managers have criticized Janet Yellen for threatening to raise interest rates in the face of weak economic data, perhaps Ms. Yellen knows from studying data that future economic growth might be more robust than we think. Another possibility is that investors are underestimating the ability for the Fed to expand their balance sheet and therefore continue to boost asset prices as David Kotok suggests courtesy of “The Big Picture” blog by Barry Ritholz: http://ritholtz.com/2016/06/feds-balance-sheet-small/
As momentum investors, we follow the trend of the market and that means that we are currently well-exposed to risk assets. Certainly a surprise Brexit later this month might cause a temporary correction in risk assets, but current analysis from Blackrock shows that the odds of a Brexit are still less than 30%. The long sideways markets that we have endured have been the greater obstacle in our view to making progress. Now that the market is close to breaking out of that range, we hope that the trend will carry us forward. We hope to ride the wall of worry wave as economic data improves in the future.
The author(s) principally responsible for the preparation of this material are expressing their own opinions and viewpoints, which are subject to change without notice and may differ from the view or opinions of others at BSAM or its affiliates. Any conclusions presented are speculative and are not intended to predict the future of any specific investment strategy. This material is based on publicly available data as of the publication date and largely dependent on third party research and information which we do not independently verify. We make no representation or warranty with respect to the accuracy or completeness of this material. One cannot use any graphs or charts, by themselves, to make an informed investment decision. Estimates of future performance are based on assumptions that may not be realized and actual events may differ from events assumed. BSAM is not acting as a fiduciary in presenting this material. Benchmark indices are presented or discussed for illustrative purposes only and do not account for deduction of fees and expenses incurred by investors. “MRI” is our proprietary Macro Risk Indicator.
The strategies discussed in this material may not be suitable for all investors. We urge you to talk with your investment adviser prior to making any investment decisions.