Last week saw markets continuing to respond to headlines like Pavlov’s Dog did the dinner bell. Take last Friday’s news that the U.S. could de-list Chinese companies from U.S. exchanges. Equities went from positive territory into a steep, downward slide.
Earlier in the week, impeachment talk had sent investors scurrying like rats from a sinking ship. Until they realized that Republicans still control the Senate. Which likely renders any such proceedings more Kabuki Theater than serious political drama. With less attention being paid to potential outcomes than on the circus leading up to it.
Still, September’s ferocious reputation as the “Year’s Worst Month for Stocks!” proved rather benign. The S&P 500 finished two percent higher. And most indices re-established the upward trendlines in place prior to July’s declines.
Of course, regardless of the market’s direction, the broader narrative remains fixated on global economic malaise and “the coming recession.” In fact, investors cannot turn in any direction without bumping into a cavalcade of expert pundits speculating upon the future direction of stocks. None of whom have a track record that would deserve any more respect than the Mayan Apocalypse proselytizers of 2012. Even though market prognosticators essentially have a 50 percent change of eventually being correct. Yet, still investors listen. Allowing the apocalyptic cacophony to influence decision making time and again.
This is not how effective decision making occurs. For that, consider Houston Astros General Manager Jeff Luhnow.
After leading multiple enterprises in Silicon Valley, Luhnow worked as a consultant for Mckinsey & Company. Only then was he lured to Major League Baseball. Putting his talents for analytics, data mining and decision sciences to work for the St. Louis Cardinals before he was hired to turn around the Houston Astros.
Had Luhnow acted like most investors when he assumed the reigns of MLB’s worst franchise in 2011, the “Disastros” would still likely be mired in 100 loss seasons, instead of having won the 2017 World Series. Setting the standard for modern-day MLB success. And entering the current post-season as favorites to win it all yet again.
Luhnow took over a team riddled with failure and implemented two critical components: 1) A focus on process, not outcomes; 2) A growth mindset throughout the organizational culture. Which is to say, an obsession with constant improvement at every level throughout the organization.
He hired rocket scientist Sig Mejdal (NASA, Lockheed Martin) and created an analytics and decision sciences department focused on improving every facet of the organization. On the field, in the clubhouse, and throughout the front office. He removed guesswork and emotion from decision making. Built a database. And learned how to mine the trove of historical data and statistics he built to incrementally improve the team in every way.
Ultimately, the processes Luhnow enacted brought Houston a long-awaited championship. And elevated the Astros to the pinnacle of baseball. By learning to how eradicate emotion and bias from routine decisions. While simultaneously integrating big data into hiring and personal decisions in a way that ultimately led to better outcomes throughout the organization.
Elsewhere, statistician Nate Silver used those same disciplines in a different field to build a system for predicting specific outcomes for highly uncertain events. From baseball to presidential elections. He became a sensation at age thirty when he made a near-perfect prediction for the 2012 election. And in so doing, solidified his standing as the nation’s foremost sports and political forecaster.
Silver uses data and statistical modeling to discern the signals from the noise. Most predictions fail because predictors have little understanding of probability and uncertainty. Often resulting in overconfidence. Which speaks to Silver’s “prediction paradox,” which holds that the more humble the forecaster in his ability to accurately predict an outcome, the more successful he’ll likely be in predicting (and planning for) the future.
Silver finds that the most accurate forecasters tend to have a superior command of probability as a concept. They tend to be humble and hardworking. They distinguish the predictable from the unpredictable. And notice a thousand little details that lead them closer to the truth. Because of their appreciation of probability, they can better distinguish signals from the noise.
Of course, investors are confronted by so many duck-billed buffoons incessantly prattling on about that which they know so little. Which muddies the waters. Making the investor’s plight all-the-more difficult. If, however, we can eliminate the noise. The thousands of messages, reports and news flashes vying for our attention. And humbly focus on that which matters most: our personal financial objectives; the meaning behind today’s most important economic metrics; and what’s really driving market movements, then perhaps we — like Luhnow and Silver — can enact more effective decision-making strategies capable of moving us ever closer to our desired outcomes.
Which leads back to today.
Tuesday morning, the S&P 500 sat within a percentage point of July’s all-time high. A day and a half later, close to three percentage points had been shaven from market capitalization. Leading us to discern two possible paths before us:
1) The market will use the spark of some catalyst (positive U.S./China Trade news, solid earnings?) to break through the technical ceiling under which it has been contained in a rising wedge pattern to attain new highs and propel itself, and investor capital, ever higher (an object in motion tends to stay in motion).
2) The market will use the spark of some catalyst (China? Poor Q3 earnings?) to fall precipitously until it reaches the lower trendline established by its recent lower lows of 8/19, 5/19, 12/18.
Alas, investors must purge their biases and emotions from their decision processes never lose sight of one truism: regardless which of the above comes to fruition, there can only be one inevitable outcome. Stocks will eventually set new all-time and highs and leap markedly higher. Might it take days? Months? Years? We can’t know. However, if we strive to discern the signals from the noise, we may be able to bask in the warm glow of our effective decision-making. Putting us in good stead as we seek to profit in the face of any and all prospective scenarios.
But enough of the future. What’s driving markets today?
Two weeks ago, the Fed cut the benchmark rate by 0.25 percent. The second cut in as many months. The decision was far from unanimous. A divided Fed cut interest rates to cushion a slowing U.S. economy from a global slowdown. Either way, the bias is toward cutting, which Mr. Market appreciates.
Despite the uncertainty, U.S. stocks rallied. Addicted, as we are, to that succulent, steaks-on-the-grill aroma of easy money. One of the drivers that have pushed stocks higher these last ten years. Trump understands this. Which explains why he’s oft vituperated Chairman Powell like a coach might a running back that repeatedly fumbles the ball. Trump seeks reelection. The economy holds the key. He will not rest until everyone is on board.
Did we need another rate cut? Probably not. As the economy’s biological age appears younger than its real age (10 years into an expansion). But, the Fed is aware of its reputation (as recession catalysts), and sensitive to what occurs overseas (where things have been less sanguine).
Specifically, the Fed has responded to slowing global growth. Germany, which accounts for one third of Europe’s economic activity, saw negative Q2 growth. Should Q3 be similar? Then Germany will find itself in recession. Even U.S. manufacturing, a bright spot till recently, has contracted.
The culprit? Trade tensions. Which have brought central banks to answer the siren’s call of slowing growth. Attempting to prime the engines of global growth via lower rates and more liquidity. Whether such efforts will prove worthwhile will be revealed later. Till then, pray that American and Chinese negotiators realize that while anyone can do the twist, it takes two to tango.
Also worrisome, the ISM Purchasing Managers Index has long been a litmus test for U.S. manufacturing. Since peaking at 60 last summer, it has steadily declined. Recently, it has fallen beneath the Mendoza Line of 50, which marks the point at which manufacturing is viewed as being expansionary or in contraction.
However, good news remains. It has traditionally taken 31 months for the economy to slip into recession following the the ISM index’s fall from its apex. Which would leave us with 18.5 months until any slowdown begins. Moreover, any good news could push the index higher yet. Resetting the clock on our ISM countdown.
Despite trade and manufacturing, recent data points to a firming U.S. housing sector. Sales of previously owned U.S. homes in August grew at the fastest pace since March of last year. As homes sales realize a boost from lower interest rates.
Finally, enjoy the start of the baseball playoffs. With so many smart, talented organizations in MLB these days, the playoffs should be a spectacle. Entertaining examples of smart organizations using analytics and decision sciences to battle it out at the highest level of their game.
Also, enjoy what remains of the summer heat prevailing throughout much of the country. As it will soon give way to the more temperate climates of fall. Bringing the leaves to change. And the kaleidoscope of coloration that comes with it.
Onward and upward…
Major indices finished down last week. DJIA lost 0.43%, S&P 500 fell 1.01%. The Nasdaq lost 2.19%. While small cap stocks fell 2.52%. 10-year Treasury bond yield fell 3 basis points to 1.68%. Gold closed at $1,497.05, down $19.85 per ounce or 1.31%.