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Grand market narratives:
In the TV show Foundation, inspired by Isaac Asimov’s novel, a mathematician predicts the collapse of the centuries-old galactic political order using a complex algorithm. While this premise is intellectually questionable, it remains emotionally captivating. The idea that societies can be accurately predicted through equations is as improbable as faster-than-light travel. Nevertheless, people have always been drawn to the concept of historical order and predictability.
If you doubt the credibility of The Great Historical Algorithm, which predicts major events, I encourage you to read Francis Fukuyama’s review of Neil Howe’s “The Fourth Turning Is Here” and Peter Turchin’s “End Times” in the New York Times. Turchin’s book is based on “cliodynamics,” a form of Big Data analysis that uses mathematical models to predict historical crises. This approach closely resembles the “psychohistory” depicted in Asimov’s sci-fi novels.
On Wall Street, investors who have achieved financial success often present grand theories and historic narratives, lending credibility to their claims. It’s tempting to take George Soros’ theory of reflexivity or Ray Dalio’s discussion of five big forces of history seriously as predictive frameworks. However, successful investors aren’t necessarily better at predicting the future; their expertise lies in understanding the present. When someone starts a conversation with “I’ve been reading a lot of history lately…,” it’s best to settle the bill.
Nevertheless, it’s important to try and anticipate the future as much as possible. If we believe that economies and markets are analyzable, it’s natural to anticipate not just cyclical shifts, but also regime changes. Deutsche Bank researchers Jim Reid, Henry Allen, and Galina Pozdnyakova recently released the third part of their long-term asset return study titled “The History (and Future) of Recessions.” The study delves into the frequency, depth, and duration of recessions in developed markets over decades and even centuries.
Their forward-facing argument suggests that the era of falling rates, low inflation, and prolonged economic expansions that began in 1982 is historically aberrant and likely coming to an end. This era was characterized by increasing globalization and active fiscal and monetary policies that softened economic downturns but resulted in significant debt accumulation. Currently, this approach is reaching its limits due to high levels of public and private debt and rising real yields. Aging demographics and deglobalization are also putting upward pressure on inflation, which could lead to more volatile interest rates and business cycles. As a result, policymakers may face more constraints, leading to a more regular pattern of boom-bust cycles and frequent recessions.
Reid and his co-authors argue that this new regime may not necessarily hinder growth. In fact, their report suggests a market fundamentalist perspective that a “natural” business cycle will stimulate innovation and growth through creative destruction. They also acknowledge the role of luck in the long business cycles of recent decades, emphasizing that the limited number of US recessions during this period is highly unusual and unlikely to continue without significant good fortune.
Many individuals, including Charles Goodhart, Manoj Pradhan, Nouriel Roubini, and Michael Hartnett, agree with or hold views closely related to this thesis. It has become somewhat of a consensus among those predicting economic regime changes. However, as an eternal skeptic, I can’t help but doubt such forecasts. History has shown that people rarely make accurate major predictions, and the popularity of this particular forecast raises questions about its appeal stemming from tidiness rather than rigor. Although my doubt should not be considered a counterargument, it’s worth noting the substantial research contained in the Reid report and its predecessors.
However, I suspect that part of the consensus view on regime change is driven by a simple observation. When looking at a long-term chart of US interest rates, it’s hard not to anticipate a regime change in which rates rise. Deutsche Bank provides their version of this chart, clearly illustrating the upward trend from 1950 to 1982, followed by a decline to near-zero levels from 1982 to 2020, implying an inevitable upward shift.
While this is not a concrete argument, it’s still worth considering. One thing is certain – it’s not science fiction.
One good read:
Explore the capitulation in San Francisco’s office market.
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