This is the second note from Demonetized, a new guest contributor. No, that isn’t his real name. Rather atypically, this guest contributor is anonymous. To you, anyway – we know who he is. But even before we did, we were admirers of his approach and many shared point of views. We don’t and won’t always agree, but we’re very happy that he’s doing some pieces for us here. We think you will be, too.
[Dollar Note with subliminal message]: THIS IS YOUR GODThey Live (1988)
If ever you find yourself struggling to keep the difference between Narrative and narrative straight, think of John Carpenter’s 1988 sci-fi action flick, They Live. No doubt it’s a goofy movie. The basic premise will be familiar to anyone who’s seen movies like Dark City or The Matrix. Reality, as we perceive it, is an illusion. But, if you obtain the gift of special sight, you may see the world as it is. In the case of They Live, you put on a pair of special sunglasses only to discover the world is, in fact, controlled by hideous aliens, which use mass media to shape our behavior with subliminal messaging.
The subliminal messages are Narrative. Mass media is the delivery vehicle.
What I love most about They Live are its “alien vision” shots. (Okay, and Roddy Piper’s iconic line: “I have come here to chew bubblegum and kick ass… and I’m all out of bubblegum”) Anyway. Back to “alien vision.” The beauty of the production design here is how sharply it contrasts the superficial optics of media we’re used to seeing every day with the blunt force of the subliminal messaging.
It’s a wonderful visualization of how symbolic abstraction operates in our world. And who knows, maybe Jerome Powell and Janet Yellen really ARE hideous aliens.
But this isn’t a note about your Friendly Neighborhood Central Bankers, or even how symbolic abstraction can be weaponized to sell you a new refrigerator. This is a note about how symbolic abstraction is used to shape your investment behavior. Both your behavior and your clients’ behavior.
Look at the below chart. You’ve probably seen it before. Maybe in a white paper. Maybe in a blog post. Maybe it hangs in the conference room where your firm hosts client meetings.
Now let’s put on our special sunglasses:
I must confess I have come to hate this chart. I don’t hate it because it’s wrong. I hate it for how it’s used, which is to imply anyone who isn’t overweight US equities is some kind of charlatan or idiot.
Why do you suppose that chart hangs in your conference room? Why that chart, and not a chart of German or Russian or Japanese equity returns? Better yet, why not that chart alongside charts of all different countries’ equity returns? Isn’t there an important point about the path dependency of investment returns to be made here?
No. There’s not. The chart doesn’t exist to educate you about the possible paths your portfolio’s performance might take, and the resulting impact on your financial position. The chart is there to send a message. It’s there to reinforce right thinking about asset allocation and portfolio construction in the minds of financial advisors and their clients.
Sure, we like to think we make investment decisions based on the objective analysis of data.
But in reality, it’s all negotiable. We modify asset allocations and financial plans all the time, for reasons that have nothing to do with data. We do it to accommodate the cognitive and emotional biases of our clients (home country bias being a prime example). We do it to protect our business relationships. Not because we’re charlatans or snake oil salesmen, but because if we don’t give a little on portfolio construction there’s a chance clients will fire us and hire real snake oil salesmen—smooth talkers who will tell them whatever they want to hear to their faces and do awful things to their finances when they’re not looking.
Most of us are overweight US stocks simply because an overweight position in US stocks has been forced upon us. We own cap-weighted index funds (particularly S&P 500 and US Total Stock Market funds) because when the US market goes up and up and up how can you do anything but get long the market while keeping fees and taxes as low as possible?
It’s right there in the data. How can we call ourselves fiduciaries if we ignore the data?
Investing according to that chart is common sense, right? I mean, we all know tactical asset allocation doesn’t work. It’s right there in the numbers.
Oops. Forgot to take off the special sunglasses. But you get the idea.
You might think by owning a bunch of index funds as cheaply and as tax efficiently as possible you can somehow “opt out” of making macro calls. “Forecasting is a fool’s game.” I get it. I’ve seen that data, too. But there’s no such thing as opting out of macro calls. Our 60/40 or 70/30 or 80/20 portfolios, implemented with the simplest, cheapest index funds and ETFs we can find, are themselves macro calls.
Now, I think there are good reasons why 60/40 portfolios have done well historically. I also think there are good reasons to be structurally overweight equities. I have a solid chunk of my own money in equities, and a healthy exposure to US equities at that. Why? Partly because it’s not clear to me capitalism works in a world where equities don’t earn a structural premium over bonds and cash. And if capitalism stops working, it’s not clear to me anything we do in our portfolios will help us build or preserve wealth. If you’re short the world, and the world goes to hell, taking the global financial system with it, then who’s left to pay you out?
Now, I can justify my macro bet in any number of ways, but I’ve still made a macro bet. It’s an implicit bet on the persistence of the conditions that have historically created equity outperformance, both in the US and abroad. It’s the kind of bet we should be making with Clear Eyes and Full Hearts.
We should place our bets after carefully weighing the various options available; our clients’ goals and circumstances; and a probabilistic view of future states of the world. We should not place bets (or do anything, for that matter) just because we’ve been conditioned to believe it’s what right-thinking and right-acting fiduciaries must do to serve their clients.
We place our bets with Clear Eyes and Full Hearts because in a Three Body Market, our bets can easily go the wrong way.
We know there are market regimes where today’s predominant macro bets won’t pay off. Ben wrote about them here: they’re the inflationary bust and the deflationary bust. Both spell trouble for equity beta. Big trouble.
And what works when cheap beta doesn’t?
All the strategies we’ve been conditioned to believe are BAD.
It’s low net long/short equity. It’s CTAs. It’s long vol and gold and discretionary global macro and farmland and pretty much everything else that’s less correlated, uncorrelated, or negatively correlated to equity beta. Basically, any bet against the successful transformation of financial markets into political utilities–any bet against the Nudging State’s agenda.
If you view the world through Clear Eyes, and hold loosely to your convictions, you’ll have an easier time adapting to a dramatic shift in the market regime than your competitors who’ve been lulled into a Narrative-induced fugue state. You’ll make up your own damn mind. You, your clients, and your business will all be better off for it.
Because we’re here to chew bubblegum and kick ass, both for ourselves and on behalf of our clients.
And, unfortunately, we’re all out of bubblegum.