Why I LOVE Being Wrong

OH MY GOD YOU WERE WRONG!

YES! And guess what? I’ll do it again. 

Nobody likes being wrong. 

I’m nobody.

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Seriously, I try really hard NOT to be wrong. But it still happens.

It’s a right pain in the arse.

I mean, it’d be so much easier to just be right all the time.

Obviously, I could choose to deny my wrongness & totally BS myself (the popular response)…

Or, the evergreen

But then I’m denying myself the full experience.

Killing the curiosity that breeds creativity, ideas, risk-taking, & hopefully compounds into better returns.

Being wrong is inevitable. Lean in. Learn to love it

Yes it’s uncomfortable, but it’s the best (only?) way to really further your understanding of, well, pretty much anything.

Take this tweet from January 2022:

These spaghetti charts are always good fun.

The perfect way to show how even a collective of the greatest minds & risk-takers with huge incentives to be right (henceforth, ‘the market’) is still REALLY bad at predicting the future.

Even though the BofA analysts were generally right (markets were underpricing Fed hikes for 2022 & 2023), they got it specifically wrong.

A peak rate of 3% at the time seemed INSANE. That’s why I posted it, and presumably why it was widely shared.

Now look where we are!

5.25%-5.50% and weighing up another hike in November…

And nobody has a clue what’s going to happen next.

One thing is guaranteed: People will be wrong about the future

Like how the soft landing chat has ramped up even though recession risks are rising…

This Bridgewater piece on US economic resilience is a great read (and kind of explains why the consensus was wrong on the recession calls 12 months back)

Why are recession risks higher?

The cushions just aren’t as big as they were.

Spending was financed primarily by borrowing and dis-saving. Now it’s being financed primarily by income growth.

That doesn’t mean a recession is imminent or nailed on. It’s just a more fragile source of spending IF companies decide to focus on the famous ‘efficiency’, protect their profit margins and start cutting costs (jobs).

These dynamics are more normal. We’ve been in supercharged mode since the pandemic.

Is The Recession LOOMING?

Right, now we’re getting into it. While it seems inevitable that a recession will arrive, these things come in all shapes and sizes.

So the bigger question is perhaps, when should we really start to worry about recession?

The obvious answer is when the labour market rolls over. Once economies start to lose jobs, that can be a hard trend to reverse.

If we’re getting a little more technical, we can look at yield spreads.

A subscriber asked us about the US 2s10s spread over the weekend:

The trajectory:

Let's start with the easiest one. Nobody cares about the 200-day moving average on a yield spread. I mean, it’s cool as a little trend indicator I guess, but no real predictive value to a spread being being above or below it.

That said, I’ve added it to this chart as a way to highlight the trend:

We’ve written about the 2s10s curve in more detail here.

The TL;DR is that the inversion of this curve (i.e. it goes negative) usually precedes recession (those big green boxes).

Warning signals are really flashing when the curve returns to positive territory. 

As for the bond market implying future rate pricing, well… yes and no.

Bond markets also reflect… supply and demand.

The US treasury is spending plenty & financing much of that via bond issuance.

I know this is groundbreaking analysis. Please don’t applaud yet.

Let me explain.

The Fed meets this week. They’re not expected to hike.

They might hike once more in November.

From the current inversion, a yield curve can steepen in one of two ways.

Either short-term rates drop below the long term rates or long-term rates rise above short term rates.

Like this:

Or it can be a bit of both.

The current spread is -0.70% or 70 basis points.

The 2 year currently yields 5.05% while the 10 year yields 4.35%

If you take the view that bond markets are always telling us things (you shouldn’t), the 2 year at 5% is dicey.

Purely based on Fed funds pricing, just one year from now, we’ll see two rate cuts. By December 2024, we’ll see three.

We’ve already talked about markets being wrong often. If rates are expected to be 4.5-4.75% in 15 months time, and the 2 year note is yielding 5.05%, somebody’s wrong.

You can perhaps argue that a weighted probability of the scenarios (one more hike in November vs 2024 cuts) gives a fair value of around 5%.

Ultimately though, it’s still likely to be a bumpy road out of inversion as markets continue the drunken walk towards a ‘normal’ yield curve (re-steepens).

This combination of large fiscal deficits, nominal growth, inflation & rising energy prices is a mix that most bond traders have only read about in textbooks.

The soft landing depends on the Fed getting the timing right and cutting rates back to neutral before the economic damage of too tight monetary policy really sets in.

Before I forget, the Apple launch event is another great example of wrongness in waiting.

After said launch event, the narrative was all about Apple being DEAD, not innovating etc. Yet early iPhone 15 demand seems to be way stronger than expected…

Is the consensus wrong on Apple? Probably. 

Is the Wedbush 12 month price target of $240 too ambitious? Almost definitely.

Is there an opportunity? Always. But is it a good one? (a whole other topic)

We’re constantly dealing with uncertainty. It’s a fact of life. In markets we’re at the sharp end.

Being wrong isn’t something to avoid. It’s merely the inevitable price of admission.

Might as well learn to love it. Maybe even get better at it…

More to come on this topic later in the week:

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