Life is messy

Welcome to 2023! I hope you all had a lovely end of the year. Since there are quite a few new readers that have joined the party, I would like to introduce you all to the purpose of these posts. Most importantly, be aware that I will not write about the market moves of the day or anything like that. These posts are an opportunity to take a step back and think about markets and economics in a more fundamental way.

But when I do that – and this is the raison d’être of these missives – I will not do this based on what some theory or model says about the world. I will almost always rely exclusively on experimental results because as an investment practitioner, I am interested in the world as it is, not as it should be.

This is important because sometimes readers feel irritated by my posts and in my experience, it is almost always because I have written something that is in contradiction to preconceived notions about how the world should work or what people have learned at university.

Let me be clear, I think most of the things I learned while studying towards my post-grad degree in economics are either wrong or worthless for practitioners. You may not think this is true, but what I do in these posts is show you empirical data that form my view of the world. We can then discuss whether the empirical results are wrong or incomplete, and I encourage all my readers to write and challenge me. But I will almost never discuss things that are based on the argument that “(ceteris paribus) if you do X then Y should happen”, or along the lines of “the model/theory developed by Nobel winning economist Z says that…”

Do you know why I don’t bother with such discussions?

Because while I have a postgrad degree in economics and finance, I first trained as a physicist and mathematician. And unlike the stuff they teach you in economics and finance classes, the stuff you learn studying physics is actually relevant in real life. And in physics (and the hard sciences in general), you build your models and theories to fit the data. In economics, all too often, empirical data that contradicts a theory is dismissed or ignored.

So, to give you an idea of what you can expect when you read these missives in the future, here are some interesting posts from 2022:

• ‘Printing money’ leads to inflation. Not in the last forty years or so.

• It was drastic increases in interest rates that ended the high inflation period of the 1970s. Except that the empirical evidence in favour of this narrative is pretty weak.

• Cutting taxes spurs growth and rising taxes reduce growth. No and no.

• Climate change is an economic disaster that we cannot adapt to. From an economic perspective, that is not the case. It’s expensive, but we can adapt.

• Macroeconomic surprises influence equity and bond markets in a predictable way. Positive growth surprises, for example lead to higher share prices. Nope, that has changed after the financial crisis.

• Equity investors try to analyse and forecast corporate earnings because that is what drives stock returns. No, they don’t. Interest rates are far more important than earnings for annual returns.

• The equity risk premium is supposed to be independent of interest rates in the long run. In the short run, it may be driven by changing investor sentiment, but surely in the long run, the equity risk premium should be constant. Except, that it doesn’t seem to be the case.

• Real interest rates are constant in the long run. Depends on your definition of ‘long run’.

As I said in the title of this post: life is messy. Financial markets and the economy do not know what your theory says. They do not react to one variable in always the same way and with the same strength. This is why I love being an investor and why I love studying the economy. They are social systems where billions of people interact with each other, and each individual has different information, incentives, biases and moods. This means there are second round, third round and fourth round effects that are hard to guess from a simple model that says “(ceteris paribus) if you do X then Y should happen”.  

If you, like me, are curious about how the world works instead of being comfortable in your knowledge that a theory or model tells you how the world should work, then keep on reading and explore the world in all its facets and surprises with me. I promise it is going to be a fun journey.