The Trending Fed

MARKETS, ECONOMIES & INSTITUTIONS ALL TREND

Everyone has heard the adage that “the trend is your friend.” It always amazes me how, despite the historical evidence supporting this principle, human nature requires that we embark on a never-ending quest to pick tops – to find divergences and indicators that support the notion that the trend is “about to change.” This speaks to two elements of human nature, I think. One, we are risk-averse, and the fear of losing money or “buying the top” drives investment strategy. And two, humanity has an inherent need to be “right” – to be the prognosticator that “called the top.” Those that have successfully called a top (even if they have spent their entire career calling a top) can typically monetize that call from an investor base that is fundamentally scared. As markets in the U.S. probe all-time highs investors should keep this in mind because typical “crash” and “top” rhetoric will accompany higher equity prices, as they always do.

Instead of picking tops, a more constructive approach for investors is to ask themselves why markets, the economy, institutions, politics, and even ideologies trend – because they all do. This speaks to another core tenet of human nature, social interaction. Trends have always been a medium by which people interact with each other, driven by a multitude of human emotion – fear, greed, popularity, the need to be part of a group etc. In general, human progression is highly cyclical, undulating between innovation, adoption, competition, and ultimately repudiation. Obviously, different eco-systems have their own peculiar time-tables and motivators, but they all have elements of this cyclicality.

The economy and markets are no different, and unlike many eco-systems, they can be leveraged, and are highly measurable. Early innovators in a market trend are usually the only ones that have capital to deploy. They see value after the proliferation of forced-selling and margin calls that always accompany market devastation. These innovators have both the capital and the foresight to act against the crowd, which is often broke and scared. Early adopters of the trend are next, followed by the mainstream, and ultimately the laggards – a cohort that is notorious for “buying tops.” The irony with laggards is that it is often the fear of buying a top that prevents their adoption of a trend, until it is too late.

The inherent difficulty of “picking tops” exists because all trends are different, with different adoption rates. But one thing to consider, as we embark on the longest expansion and bull market on record, is that size matters, and here I will make a simple physics analogy. In Newtonian mechanics, momentum is equal to mass times velocity. As the U.S. economy continues to grow it will take longer to both stimulate and slow-down via monetary and fiscal policy. The larger and faster the train, the less effective its brake system will be. Similarly, re-starting that train will require even more additional force. Nobody knows when this expansion will end but analyzing it in terms of duration is a flawed approach. It has lasted longer than any other, and for good reason, stimulus took longer to “restart the train” and tightening will likely take longer to slow it down.