The Irreverent Economist

The Siren Song of Wall Street

Do yourself a favor and turn off CNBC.

For as long as I’ve been in the financial industry, pundits have made an opulent living by telling tales about markets.  Flowery narratives which weave together the latest bellwether corporate earnings report or widely-followed employment indicator are utterly useless for sound investment decision-making.

To be clear, these orations tell us plenty about the current state of the economy.  However, they frequently make unsubstantiated leaps toward statements about future investment returns.  The wisdom of crowds suggests financial markets discount future outcomes well before they occur.  By the time Apple’s earnings or the latest payrolls reports are released, publicly-traded securities have already reflected such "news."  Hence the adage, “buy the rumor, sell the fact.”  Nonetheless, most investors listen intently as financial demagogues whisper sweet nothings into their ears.

We Paladins follow a different route.  We respect markets’ effectiveness at discounting future outcomes.  This means that most opinion and publicly available information is noise - and counterproductive to our goal of achieving superior risk-adjusted returns.  It should be ignored.  That said, we do not advocate a passive allocation approach.  Financial markets trace out long cycles—many elements of which are predictable—and occasionally deviate meaningfully from fundamentals.  We’ve focused our efforts on studying these cyclical patterns, in an effort to identify their signposts.

Why is all this relevant now?  Because virtually every one of our preferred cycle indicators identify the present conditions as an historic selling opportunity:

  • On most measures, stock market valuations are the highest-ever outside of the Dotcom Bubble.  On some measures, valuations are indeed at all-time records.
  • Input costs and interest rates have risen (and market liquidity has tightened) to a degree that is comparable to the conditions that preceded prior economic/market downturns.
  • The breadth of corporate earnings growth (and stock market performance) has narrowed considerably—foreshadowing a downturn in capital spending.
  • Stock market positioning (as measured by the futures market) and sentiment gauges indicate that retail investors are way out over their skis.  Similarly, institutional investors are betting heavily against “safe” assets such as US Treasury bonds.

Wall Street’s soothsayers—who are invariably bullish—will continue to quote record year-over-year growth in corporate earnings, still-low interest rates, high rates of employment, and a pro-economy agenda in Washington.  Remember: these facts are well known, and already reflected in stock prices.  Masquerading as financial advice, this touting of the party line is designed to keep you fully invested and the Wall Street machine humming.

Ignore the siren song.  This is a time for capital preservation, not market speculation.


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