It is as if ingrained in us, hardwired
to our brains and most likely inherited from our ancestors from long ago.
Ancestors that very much depended on being able to anticipate the near term with
enough precision to survive a rapidly evolving and inhospitable environment. That
habitat is no more[1], but our
desire to anticipate remains.
Right now, one of the world’s major preoccupations
is the Ebola virus, a horrible hemorrhagic fever that seems to be spreading
like wildfire. What was merely a footnote is now front page headlines.
Governments are waking up, pharmaceuticals are concocting experimental drugs and
markets have been shunning airline stocks[2].
That last observation about airline stocks is an interesting one, as it seems
to be entirely driven by a sort of narrative.
That narrative goes something like this:
The Ebola virus is spreading exponentially, it may soon get out of control and may
eventually threaten our very existence. Really? How did we get from very local
to global threat? The clues may lie in the uncertainties built into the narrative.
We don’t know, for example, if the Ebola
virus could eventually mutate into a more “virulent” and deadly form. We don’t
know if we will develop the technological means in time to put an end to it and
we don’t know whether it may just plateau on its own and subside from there on
(like many epidemics seem to have done before it).
It
just happens to be that uncertainty fuels the narrative, which in turn
amplifies that “uncertainty” effect. This “negative feedback loop” is the basic
mechanism by which rational becomes irrational and order switches to panic.
The markets have been infected by a “thought”
virus, spreading through contagion just like a real disease would. When you
combine our need to decipher the future with a potential threat in that future,
and dose it with enough uncertainty, the result is frequently trouble. The
uncertainty acts as the lubricant that helps spread the “thought” virus.
Markets, perhaps unsurprisingly, function
similarly, with movements and trends being influenced in large part by a
collective “narrative” of the participants. The recent spike in volatilities is
a case in point, symptomatic of a narrative-based “thought” virus contagion.
Until recently the consensus narrative has been one of slow but steady global economic
healing spurred by an extended period of heavy handed central bank intervention
in capital markets.
Businesses have also contributed to this
by nurturing an overly upbeat sentiment. Corporate earnings have remained strong
over a long stretch, thanks to a combination of cheap borrowing, low wages and healthy
export demand. This, in turn boosted stocks, fuelling a “positive feedback loop”
that remained despite the protracted period of weak growth, high unemployment
and deep structural deficiencies.
The narrative went probably something
like this: the authorities are firmly in control, inflation is tamed, markets
are calm and corporate earnings couldn’t be healthier. Investors were also
under peer pressure to perform in a low-volatility, bull market environment. Governments
cranked up that pressure by significantly raising the cost of staying on the
sidelines[3].
The previous narratives of “new normal /
ring of fire” around the time of the Greek sovereign bond crisis in 2010 was
put on hold. That changed as new threats began to appear on the horizon[4],
tipping the balance towards a newly minted “secular stagnation” thought virus. The
ensuing spike in volatilities reflects the growing uncertainties that the new
worries carry.
So, in effect, there hasn’t been much of
a real change on the ground. The global economy was stuck in a “new normal”, lower
secular growth all along, and that narrative is starting to sink in again[5].
To make matters worse, many of the problems that brought us here in the first
place have not been resolved. From the urgent need for banking reform in the
Eurozone to the global impact of a maturing economy in China, the troubles will
endure. That is until a new “thought virus” sway markets in another direction.
[1] Through
our superior intelligence we have succeeded in taming our habitat, eliminating
most of the natural threats but also introducing new ones in the form of damage
to the environment.
[2] Airline
stocks are being battered as the market is anticipating earnings losses
resulting from travel being hindered if the Ebola virus continues to spread.
This is a good example of psychologically induced trading with uncertainty
pushing sentiment towards irrationality.
[3] Most
notably by bailing out troubled firms and institutions, instead of letting them
fail (instilling a moral hazard mindset) and through a generous amount of
quantitative easing activity over an extended period. One
side effect of this is the growing complacency that has also contributed in
fueling the bull market.
[4] The
emergence of Ebola as a global threat, geopolitical tensions in the caucuses
and Middle East, deflationary risk in Europe, Hong Kong protests and further signs
of economic slowdown in China have all contributed to the formation of a new “secular
stagnation” narrative.
[5] “Secular
stagnation” is in fact a worse condition than “new normal” as it threatens the
global economy with another bout of recessions. In that sense we could argue
that it is a different narrative to that of the “new normal” but also a
possible consequence of it.
