The Forces Already in Motion

The place to start is to differentiate market forecasts from forces that are already in motion.

You are receiving this email because you are a subscriber to Of Two Minds / Charles Hugh Smith. This is Musings Report 2023-40.

Readers have asked me for my opinion/forecast about the economy and markets--where stocks, bonds, yields, etc. are likely to go. I am not an expert, of course, but I read a lot of forecasts, and can identify forecasts that have been accurate and those which were  less accurate. 

As we all know, timing matters in forecasting. A forecast can be right in direction but not in timing.

The place to start is to differentiate market forecasts from forces that are already in motion. Markets are based on human perceptions of risk, loss and gain and the emotions of uncertainty, confidence, greed and fear.

Markets reflect the herd's perceptions and emotions, and if these are misaligned with actual conditions, then the market can veer into irrationality and stay there longer than seems, well, rational. So traders can keep bidding up investments at the top of what is later recognized as a bubble, and sell investments at the bottom in a panic to escape bigger losses.

Perception and emotion are amplified in markets priced on the margins, where dynamically shifting supply and demand have outsized impacts on price movements. The oil market is an example of a commodity priced on the margin that is notorious for swinging between highs and lows. It's difficult to forecast such markets, and so we see predictions of $30 per barrel and $300 per barrel. Both are plausible at peaks and troughs. 

Forces that are already in motion are not mere perception or emotion. Demographics, for example, is a statement of statistical fact. We can have an emotional response to the facts and make forecasts based on our interpretation of the facts, but demographics are not markets: demographics don't fluctuate with the emotions of the participants; demographics influence the economy and society in ways that are not matters of perception or emotion.

These long-term, systemic forces may not influence markets for quite some time, for the herd can cling quite confidently to magical thinking / euphoria / greed and support this confidence with a great many plausible rationalizations.  

What we can forecast with some confidence is the forces already in motion will impact the economy and society, and these impacts will likely influence markets once they are undeniable.

Here's an example: commercial real estate (CRE). The transition to remote work was in motion for years, as the technology came online to enable it. The pandemic lockdown accelerated this from a techie lifestyle to the mainstream, normalizing remote work in a brief period of time. Prescient owners of commercial office space may have sold their properties as soon as the pandemic lockdown ended. The less prescient did not grasp this systemic repricing of CRE until defaults and soaring vacancy rates forced a reappraisal of value, risk and loss.

Magical thinking is now in play, as those with little construction experience cling to the hope that empty office towers can be converted into residential units. This conversion is horribly costly and complex, and simply isn't financially viable unless prices for the converted units are at nosebleed levels.

Remote work has gutted CRE which is in turn gutting banks and downtowns. The market value of all these dominoes is still in flux, but the losses are already immense. What was considered rock-solid value is now melting into air. This repricing of value is disruptive, and while fortunes have been made to replace those that have been lost, this replacement of one fortune by another is not guaranteed.