What’s happening in the world?
“Convergence” by Jackson Pollack. Source: Albright-Knox Art Gallery
Chaos. At least, what appears to be chaos.
England just saw its third terrorist strike in three months. I had to double-check the dateline on the news article I was reading this weekend to be sure it wasn’t from last March. The details of the story seemed so similar. Donald Trump pulled out of the Paris climate agreement, a move supported by conservatives by widely panned by many others, including political, business, and religious leaders. Saudi Arabia and four allies have cut off diplomatic and economic ties to Qatar – a move designed to punish the gulf state known as the home of the Al-Jazeera media network.
Events are so disquieting that they seem to resemble a Jackson Pollack painting: news is splattered everywhere, from all sides, with little bits of everyday life making their way into the composition: pennies, matches, paper.
In the middle of all this, stocks in the US are near record values, lifted by prospects for record earnings during a period of low and stable inflation and even lower interest rates. When rates are low the present value of financial assets increases. The value of companies that can create disruptive growth in a slow-growth world can soar – which partially explains the boom in big tech stocks. Most foreign markets are doing better than the US. They’ve lagged behind the US for years, and now they appear to be catching up. The Dow is up 7%, while Japan is up almost twice that in dollar terms, and Europe has risen even more. And financial volatility everywhere is extremely low.
How can this be? How do we reconcile record market levels with record anxiety? How can we understand low market volatility in the light of high political uncertainty?
The answer is at least partially due to diversity and covariance. When the world is in crisis, everything moves together. If we’re worried that our entire financial architecture is crumbling, then every firm is at risk. If credit collapses, the economy will follow. Stocks move together, covariance is high, and the entire market bears the burden of a potential economic downturn. But our current political and economic climate – for all its faults – is not one of crisis and revolution, but reform and incremental change. The nationalistic populism we see isn’t one of torches and pitchforks but deal-making and reality TV.
This creates winners and losers in the economy – and the market – as company fortunes diverge. As a result, while individual stock volatility may be significant, overall market volatility has fallen – even while we worry that climate change and immigration restrictions may limit potential economic growth. Again, there will be winners and losers from such policies.
The market climbs a wall of worry, and the current climate has given us plenty to worry about. Let’s hope these worries don’t sprout and grow into real-life crises. A crisis has a way of unifying us – but that only happens when things are going wrong. In our current situation, we should celebrate diversity.
Douglas R. Tengdin, CFA