STREET DOGS

From Howard Marks’s January Memo: why do cycles occur? Why doesn’t the US economy just grow at the average rate of 2% to 3% every year? And since the average return on the S&P 500 is in the range of 9% to 11%, why isn’t the return between 9% and 11% every year (and why does the yearly return fall between 9% and 11% so infrequently)?

Because of the involvement of people. Economies and markets, as well as other cyclical phenomena, tend first to overshoot in one direction (given how people are wired, usually to the upside) and then are bound to correct in the opposite direction.

When markets do too well for a while — when equity returns far exceed the growth rate of companies’ profits, and when bonds return more than their promised yield to maturity — it usually means they’ve become overpriced and will correct sooner or later. And when an economy expands faster than the potential growth rate determined by its population growth and increases in productivity — usually because companies or consumers borrow, invest or spend to excess — it’s likely to contract eventually. This happens either because the excesses are unsustainable in and of themselves or because central bankers take steps to cool things off to avert hyperinflation.

That’s the common thread here: markets that may have been doing too well, and an economy that may be in the process of being overstimulated. Both feel good right now, but each has potential negative consequences.

There are two things I would never say (since they require far more certainty than I consider attainable): “get out” and “it’s time”. It’s rare for the market pendulum to reach such an extreme that views can properly be black or white. Most markets are far too uncertain and nuanced to permit such unequivocal, sweeping statements.