Inflation and the Common Knowledge Game

At whatever point in time you think inflation will start to fade, you are being too optimistic.

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  1. “the only thing that changes behavior is when the little girl (what game theory would call a Missionary) announces the Emperor’s nudity loudly enough so that the entire crowd believes that everyone else in the crowd heard the news. That’s when behavior changes. That’s when behavior changes FAST.”

    Smacked me right between the eyes.

    Thanks, Ben.

  2. I’ll repost this from elsewhere but I’ll tweak it for this topic.

    Here’s how this works, and it’s pretty obvious to anyone paying attention:

    1. No, inflation isn’t real.
    2. Ok maybe inflation is real but it’s only going to hurt the wealthy.
    3. Akshually it’s a good thing that inflation is here, we never said it wasn’t, and frankly we think it’s pretty {insert undesirable ad hominem} that you’d even object in the first place because now poor people are making more money.
    4. (After some polling comes in) Oh shit, maybe inflation isn’t a good thing and maybe it doesn’t help the poor after all. Somebody :tm: needs to do something about this.

    The playbook is pretty standard and frankly it bores me that nobody has come up with anything more clever than this.

  3. Avatar for jrs jrs says:

    I was born in the early 80s, so as Ben implies I have no experience with inflation. Does anyone have a good read on exactly what the inflation playbook or common knowledge to protect oneself from inflation was the last time it happened in the 1970s?

    I did read John T Reed’s Protect Your Life Savings From Hyperinflation and Depression. Reed was a real estate investor in the 1970s and has done a lot of research on other inflationary periods throughout history. Reed has obvious political biases and he needs a good editor, but I basically learned 2 things about inflationary times from this book:

    1. The value of bonds will usually decrease. The value of stocks, surprisingly to me, will be variable. Sometimes they go up in inflationary times, sometimes down.

    2. The best way to protect myself and my family from ruin during inflation (and depression!) is to own everything we will ever need, today, or the means to produce it, as much as possible. Of course, this can be a very expensive strategy. Reed writes about how his father’s family owned a farm in West Virginia during the Great Depression and their life pretty much went on as usual since they were self-sufficient. But it was a hard life and Reed’s father hated it, moving to the city and eventually becoming an alcoholic.

    Do we agree that this was the common knowledge of the 1970s? Or is Reed’s perspective an outlier?

    I am also curious for Ben or someone else to unpack this quote specifically in the context of inflationary times:

    Your embrace of the cult of Vanguard, at least as that cult is expressed today as the worship of passive index funds, will give you pain rather than comfort.

    I am no longer a big fan of index funds (“but compared to what?”). But naively, I would think that owning index funds is riskier in deflationary times than inflationary. Since in deflationary times you know everything is correlated to move down together, no?

  4. I’ve read Powell’s speech from last week 3 or 4 times. Partly, because of the change in the way he talked about pandemic now contributing to inflation vs. deflationary in the past. Conveniently, now everyone this week believes omicron is weaker and the pandemic is effectively over, so supply chains will normalize in 2022.

    That has and continues to seem “too easy”, but I guess the next pivot point is trying to predict when everyone figures out we “are being too optimistic”.

    For some reason, all I can think about is Goldman reiterating Dalio for 2022, saying “Cash is trash”.

    Screenshot 2021-12-08 113756

  5. Avatar for bhunt bhunt says:

    Don’t have a view on John T Reed, @jrs , but I’ll try to unpack that quote about passive index funds.

    Your embrace of the cult of Vanguard, at least as that cult is expressed today as the worship of passive index funds, will give you pain rather than comfort.

    The basic idea here is that a) there’s not a Fed-supplied liquidity tide lifting all equity boats in a tightening cycle, and b) as we’re seeing in the tech sector today, there are a lot of losers and not just all-winners when the narrative barge changes course and starts moving in the other direction. Specifically, I think we’re looking at a prolonged period of multiple contraction for “story stocks”, which will hit the largest S&P 500 sector weighting - tech - the hardest.

    Bottom line - I think that there’s ‘space’ for stock-picking to work again as these tectonic plate narrative regimes shift, which is (relatively) bad for passive index funds and particularly bad as you’ll see real assets (as opposed to financial assets like an index fund) go up more sharply and with a big drum-beating narrative.

  6. Avatar for jrs jrs says:

    I think I understand. So your quote is contingent on (a) the Fed raising rates (etc) rather than letting the party continue. And your (b) boils down to that old quote about swimming naked when the tide goes out. So you’re not speaking of inflation in isolation, but rather as coupled to the government’s likely response to it.

    The Boglehead narrative is that active stock-picking does not work and has never worked. And to the extent that it does work, it is ultimately due to insider information in one way or another. The narrative is that multiple papers have been published showing eventual reversion to the mean for most or all active strategies studied, meaning the pickers just got lucky.

    That part of the narrative still rings true to me, although maybe it’s just a crutch for my own financial ignorance and laziness. (And if so, then I am one of millions of doctors and other non-financial professionals who are so fooled. And our Missionaries like Jim Dahle and William Bernstein are similarly fooled.)

    So, to perhaps unfairly frame this in the Boglehead way: Are you aware of any study or other evidence showing that any active strategy consistently made money, +/- before our current water became a thing?

    (Now that I write it out like this, I see that this question may be impossible to answer rigorously, as it seems common knowledge among active investors that soft insider information was much easier to get before the 1990s or so.)

  7. Avatar for Zenzei Zenzei says:

    Can I suggest a different avenue of inquisition to arrive at an understanding of how the Water may be changing?

    Personally, I am very interested in the idea that the game is not shifting between “active” and “passive” but between content and system. In other words, that what is happening is not really about the content in the system (the securities themselves) and strategies on how to play them, but about structural changes to the system itself; changes that are redefining the game.

    For example, Bogle argues that above a certain level of indexing the system equilibrium breaks down. I’ve seen estimates that it happens around 80% active. We are currently around 40% or so which suggests we are halfway there. If this view is correct, at what point in the run from 0-80% does the disequilibrium start to make itself felt? Is it linear decay? Exponential decay? Etc?

    And more interestingly, if the disequilibrium in the system pushes the market into a one-sided NGU regime - I wonder what happens to “reversion to the mean”? And if that breaks down - what happens to most of our conventional financial theory?

    Anyway - hopefully this helps you think differently about markets in a constructive way. :slight_smile:

  8. Great book to read as an investor. Not being a polyanna here btw, just being a shrewd clear eyes full hearts guy.

  9. It appears the “common knowledge” regarding inflation, has also made it to the White House. In my opinion, really stupid to try and get in front of this number with a presidential speech.

  10. Avatar for bhunt bhunt says:

    LOL. Completely agree, @Carl_Richards . I guess the print tomorrow is REALLY bad!

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