In an very interesting and well-researched piece in The Financial Times yesterday, authors Anousha Sakoui and Izabella Kaminska described a recent phenomenon (which has also been noted during other recessionary periods) whereby various financial markets have been moving ever-closer in lockstep as economic woes continue. They provide evidence that this is not only occurring within asset classes, such as large cap stocks, but more interestingly between asset classes as well. For example, it seems that there have been close correlations between certain commodities and currencies and even oil and the stock market, assets which have been inversely correlated in the past.
Though several explanations are given, including the rise of ETFs, it is interesting to note that one possible cause, pure macro-economic conditions, probably provides the most useful lesson to shelve for future use.
In an upturn in the business cycle, while it is true that the rising tide of macro-economic factors can catch all ships, it is also true that discrepencies in earnings, increased merger activity, more frenzied hiring activity and hot sectors all produce relative winners and losers. While many investors make money in a bull market, stock pickers have an opportunity to really differentiate themselves as little cash stays on the sidelines and money floods into the markets looking for the next big stock or commodity play.
However, in the midst of a long-term bear market, it is more difficult to pick winners, particularly in the short-term. Continuing the analogy, a falling tide strands all ships. Today's environment provides a good example. Almost all employers (except for the federal government, a different article for a different day) have hiring freezes on. Investors, both of the institutional and retail variety, have collectively parked trillions of dollars in investible assets in money market and other short-term funds. The heads of the US economy have shown little enthusiasm for the prospects of the short-term recovery. And when people are gloomy in the near term, longer term issues, such as pension entitlements, government spending, and trade deficits seem to loom a little larger.
So is the true lesson simply that assets move together when markets are down? Is it that stockpicking is difficult in a down market? While those are certainly helpful, there is a bit more that can be extrapolated from this data. It is worth noting that the lessons below have different time focuses...a critical factor that avoids contradictions.
Firstly, and with a touch of the new-age spirituality so often lacking on Wall Street; investors should avoid getting frustrated during future downturns and focus on the macro signals. If things are so bad that everyone is on the sidelines, it might be worth staying on the sidelines, at least short-term. In these situations, even doing homework and due diligence can fail to protect investors from the broader macro-environment. When the global economy contracts, stock charts, earnings reports and divination rods can all be dispensed with. In other words, and with the help of a mixed pair of cliches, don't fight the market; sometimes being a sheep doesn't lead you to, but actually away from, slaughter.
Despite this, and here is the more bullish lesson; if macro-economic conditions mean that good assets are being pulled down with poor ones, it could be a tremendously strong buy opportunity for those who have the stomach for it and are ready to do some homework. Indeed, it could be the best time possible to be buying best in class assets. This may mean shifting investment horizons as it could take some time for bets to pay off. However, even the most cynical bears believe that the market will recover at some point. It could pay to get ahead of that wave.
Therefore, I supposed that the ultimate lesson, simple indeed, but so often ignored, is this; listen to the markets, then buy low and sell high. If it were only so easy...