I Can’t Explain

So, what was it that caused the sell-off in risky assets and sharp increase in volatility? The Fed? The Bank of Japan? The end of an AI bubble? A soft employment number? The yen carry trade unwinding? All of the above? Something else entirely? Who knows? The truth is that financial markets are a complex, chaotic and deeply intertwined beast, which makes both predictions and explanations impossibly difficult. Not that this stops us attempting both. For most investors a rationalisation of events doesn’t even matter – markets are volatile; sometimes uncomfortable and inexplicable things occur. What’s more important is what happens to us during bouts of market turbulence. This is where the real damage is done.

Here are a few things to bear in mind:

– The fact that people are scrambling around to decipher what happened in recent days should be a salutary lesson in the folly of market predictions. We can’t even give confident explanations for events after they have occurred, what makes us think we can do it before!?

– When an unpredictable event occurs it unfortunately makes us increasingly susceptible to forecasts. We feel anxious and uncertain, so become even more desperate than usual for a comforting guide to the future.

– People who didn’t predict the market sell-off will confidently foresee what is to come: “I didn’t see this coming, I cannot explain what caused it, but I am going to tell you what happens next.”

– Trading around market / economic events is unbelievably hard. We only need to look at the wildly varying expectations for Fed policy through 2024 to see how fiendishly tough it is to do well.

– Everyone will start to say that “uncertainty has increased”. This cannot be true. It makes no sense to claim that we were more certain about things before an unpredictable occurrence. Markets are always uncertain, sometimes we are complacent.

– Living through periods of market tumult is always challenging, even over short horizons. It is far easier to deal with such spells in theory than in practice.

– A new market narrative will take hold incredibly quickly and everyone will start using a fresh set of buzzwords that are consistent with the current set of events.

– We will forget all of our prior market pontifications no matter how recently made. Nobody will remember panicking about stagflation / a rebound in inflation after some hot data prints a few months’ back.

– Everything seems obvious after the event. Of course US employment was weakening, of course the Mag 7 would come under pressure, of course the yen carry trade was a tinderbox.

– What is happening right now will be the most important thing, and we will easily and quickly extrapolate into the future.

– The present value of future cash flows from Japanese companies is not changing by 10% a day.

– This might turn into something more substantial, or we might be talking about something else next month. Usually it is the latter, sometimes it is the former.

Living through periods of turbulence is taxing. It is easy to talk about the long-term, staying invested, and compounding returns when markets are going up. It is an entirely different story when the reverse is true, but these are the times when behaviour really counts.

Source: Joe Wiggins, Behavioural Investment, 6th August 2024. 

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