Throw Away the Old Playbook

"Much of the confusion about the current state of the economy has its origin in people trying to apply classic business-cycle analysis to COVID-19 macro distortions." Dario Perkins, TS Lombard


I could feel my blood pressure rising.


I was watching a Chief Investment Officer on TV explaining in oddly specific detail the S&P's journey throughout 2022.


He went on with similar fancy-sounding narratives about inflation, bond yields, economic growth, etc.


Part of his schtick was drawing a line from previous economic and market cycles to what was happening today.


I had listened to hundreds of these performances in my career, both on TV and in person. Why the hell was this one bothering me so much?


I didn't know the answer until I stumbled upon a blog post titled, "Don't Extrapolate From This Fake Business Cycle." by TS Lombard's Dario Perkins.


This quote from the author Dario Perkins summarized my feelings, which I was struggling to put into words...


"The more I study this COVID-distorted economy, the more uncertain I feel about what is really going on. It is hard enough to understand what is happening today, let alone make forecasts (or, worse, try to identify new “secular” long-term trends).


Yet, consensus forecasts are all clustered around a unitary, Goldilocks-type macro narrative. This seems odd. With the possible exception of the period immediately after WW2, the economy we have today is not like anything we have seen before."


In other words, it's a mistake to use distorted data today to project long-term trends. But that's exactly what is happening from Wall Street to your next-door neighbor.


In my opinion, we would all be better off with an attitude of...


"Wait, this isn't really a normal environment. I think it would be a mistake to extrapolate the current trends into the future. It would also be foolish to make large allocation changes in my portfolio based on what's happening now."


Instead, we're getting the old guard drawing up the next play based on what happened in past cycles.


This phenomenon isn't limited to Wall Street forecasters and capital allocators.


Take the Fed, they make monetary policy decisions based on labor markets (full employment) and inflation.


It's not a stretch to say both labor and inflation are a confusing mess.


Yet, the Fed is making interest rate decisions based on a noisy data set.


*This isn't a knock on the Fed, rather a nod to the impossible task they have*


What's the solution to think more clearly and make better allocation decisions in the COVID economy?


It's okay to say "I don't know"


Keep an open mind


Stay flexible. Change your mind when the facts change


Avoid stupidity rather than seeking brilliance


Don't anchor to one narrative or identity


During the early days of the pandemic, financial markets moved in wild gyrations, confounding even the most seasoned investors. Our linear minds struggled to reconcile what was happening in the economy and in the ebb and flow of equities.


I feel like we are setting up for the same mistakes today, drawing lines from past economic & market cycles to explain what is happening today, and what happens in the future.


The problem is COVID has distorted everything from supply chains, labor markets, and aggregate demand.


Forecasting in this environment is like trying to predict the winner of a chess match, but the rules randomly change at every turn. It's impossible to know what's happening or what game is being played.


During a global pandemic, maybe we all would be better off throwing away the old playbook?

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