Will Higher Interest Rates Demolish Equities?
It is commonly supposed that the higher interest rates currently being deployed by central banks to address inflation are very likely to depress share prices. US data suggests that inflation is the bigger danger.
For the period 1928 to 2021 annual returns show:
With rising inflation average returns sat at 5.6%
With falling inflation average returns sat at 14.7%
In contrast
With rising interest rates average returns sat at 9.7%
With falling interest rates average returns sat at 9.6%
Data: Ben Carlson drawing on US Securities data (Blog A Wealth of Common Sense)
There seems to be no discernible trend associated with interest rates whereas rising inflation seems to be worse news than falling inflation – at least for the US. A proximate explanation may be that inflation, being an across-the-board erosion in purchasing power, is difficult to escape whereas share prices being driven by numerous factors only one of which is the immediate cost of money (at least in the shorter term) exhibit a more muted response to interest rate rises.
Subjective Superiority
In their path breaking paper of Kahneman and Tversky worked with perhaps the two major breakthroughs that set the scene, explicitly, for the cognitive behavioural movement that developed from there on. At last count in that rough but for these purposes reliable enough source Wikipedia I found no fewer than 173 allegedly different but supposedly identifiable cognitive biases, tendencies and distortions. Really? A reasonable argument exists to suggest that by far the majority of these can, given some thought, be collapsed to the original Kahneman and Tversky categories “framing” and “risk aversity”. Their elaboration may or may not be useful depending on purpose which might span a spectrum stretching from pursuit of understanding to the attaining of tenure.
A category which remains at best implicit and is, at the other extreme simply missing I chose to call “Subjective Superiority Dominance”. This term seeks to capture the propensity we seem to have for:
- Thinking we have the best judgment, the closest to true explanation, that we make the wisest of choices, that our conclusions are the best, and in assessing our own interpretations of the myriad situations and activities which make up life, we see ours in a more favourable light than those of others. In short, our ubiquitous conviction that on most if not all matters we are “right” relative to the alternatives; and what’s more,
- We are frequently of the view that others ought to adopt our views, preferences (for music, art, books and so on), and favoured explanations. We see our views as correct and right not just for us but for all others since they are “right”. Period. Others we think, would be better off through adopting our views and abandoning the errors of their ways in favour of our superior approach to whatever is in question.
My suggestion here is not so much that this habit, bias or tendency arises from some base motivation, absence of intellect or malfeasance but rather that it exists in readily documented form to (no doubt) greater and lesser extents as a close to universal trait and is thus a factor ever influencing behaviour.
This factor is I believe critical in trying to better understand explanatory schemes.
The notion is explored further elsewhere, and a better description of the phenomenon appears in James Otteson’s “Seven Deadly Economic Sins”, Cambridge University Press, 2021.
First approximation of equity declines
While the reason for each decline may differ, market pullbacks are part of the game. Based on history, in the US at least, for equities markets we can expect drawdowns of:
- Down 10% every 10-12 months;
- Down 20% roughly every four years; and
- Down 30% approximately every 10 years.
Obviously, even bigger declines can occur. Seeking more precision than this is spurious. Accepting this is prudent. Managing for it successfully is one holy grail.
Justified True Belief
It has long seemed to me that the oft cited definition of knowledge (and it harks back at least as far as Aristotle I think, and thus has pedigree) as “justified true belief” is a problem. The concepts of “truth” and “belief” do not sit happily in the same sentence. Even the most modest respect for logic would suggest that “belief” as an idea hinges crucially on the notion that in spite of a lack of evidence, “such and such” is nonetheless the case. Suggesting then that “truth” – a statement of what indeed is the case – can be justified on the basis of belief does involve some sort of mental flip which redefines belief itself. Surely it won’t do. Neither will provenance nor longevity make it so.
Memory History Reality
From Ralph Ellison’s essay on Minton’s Playhouse, 1958:
[Of] those who came to Minton’s… no one retained more than a fragment of its happening. Afterward the very effort to put the fragments together transformed them – so that in place of true memory they now summon to mind pieces of legend. They retell the stories as they have been told and written, glamorized, inflated, made neat and smooth, with all incomprehensible details vanished along with most of the wonder. (quoted by DeVeaux, S. in The Birth of Bebop, Univ of California 1997.)
Which is a useful description of how the process of recalling and retelling risks draining the very life out of the events we seek to capture. This is a fundamental limitation of any method we might devise for describing or relaying objectivity. Dealing in objectivity becomes elusive and awkward.
Taking Risk Seriously
A friend, Stephen Jennings, has always had a great knack for expressing tough ideas very succinctly. Here he is on risk – very pithy, apparently obvious, but frequently ignored here is one of his summaries of risk:
If you want to do risky things, you have to accept that things will go wrong. You can’t say you’ll take the good times and have a lot of success then be resentful when things don’t go well.”
11 Jan 2022
Thought starter
The famed biologist E.O. Wilson recently died aged 92. Amongst the Twitter posts noting this I read this quote of his: “The love of complexity without reductionism makes art; the love of complexity with reductionism makes science.”
A first reaction was mental rehearsal of all the arguments purporting to demonstrate that reductionism involves simplistic analysis of complexity such that essential elements of whatever is in question are either missed altogether, or understated, or distorted or become, at least, severely underrepresented. The opposite end of the argument typically sees art as involving romantic waffle bearing little resemblance to empirical observation, sloppy concepts, unmeasured dimensions, unworkable descriptions, and at least unacceptably loose thinking. The midpoint might be thought of as involving all the cowardice of no mans land with an accompanying lack of progress in any direction.
A bit of thought suggests that the statement is worth digging around in for a bit – not least because Wilson was one of the worlds serious thinkers and astute observers, his statement involves no judgment and is likely to have been made after some form of due consideration. Surely there are insights here?
List of Initial Planks
Here is the first list of planks or building blocks for the discussion of explanations and explanatory models. It is likely incomplete but that is not fatal:
- All explanations (and models – a term I subsume within “explanation”) are stories;
- Concepts such as “reality”, “actual”, “real”, “truth”, “true”, “fact” or “exists” are of no relevance as generic undefined concepts;
- All stories are provisional and are expected to change, be updated, altered and added to (or subtracted from);
- The measure of a “good story” versus a “bad story” is whether or not and to what extent it fulfils its purpose;
- The correspondence of a story to anything else – most noticeably to “objective reality” is irrelevant, likely unmeasurable and often unhelpful; and,
- A purpose is a specified intent of some kind and may have a short or long life, may be broad or narrow and may be familiar or unfamiliar and much else.
Given that some sort of beginning is required, this will start things moving.
Some other points will be set out to amplify the above. These will also be incomplete, but their purpose is to lend some flesh to the bare bones laid out above.
Why reform is demanding
As NZ struggles to reform the RMA, some idea of the impact of NIMBY problems as well as the catyclismic events required to nullify them can gained from this:
The London Blitz and the NIMBYs
by Tyler Cowen December 11, 2021 at 2:16 pm in
NIMBYs can be so bad that they make the London Blitz look good:
We exploit locally exogenous variation from the Blitz bombings to quantify the effect of redevelopment frictions and identify agglomeration economies at a micro-geographic scale. Employing rich location and office rental transaction data, we estimate reduced-form analyses and a spatial general equilibrium model. Our analyses demonstrate that more heavily bombed areas exhibit taller buildings today, and that agglomeration elasticities in London are large, approaching 0.2. Counterfactual simulations show that if the Blitz had not occurred, the concomitant reduction in agglomeration economies arising from the loss of higher-density redevelopment would cause London’s present-day gross domestic product to drop by some 10% (or £50 billion).
Here is the full paper by Gerard H Dericks and Hans R A Koster, via tekl.
Eye2theLongRun 