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Musings Report 2025-14 4-5-25 If We Get the Context Wrong, We're Flying Blind
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If We Get the Context Wrong, We're Flying Blind
If we get the context of what's happening in real time wrong, we're flying blind in low-visibility rough weather. Flying blind in these conditions makes it easy to make poor decisions--decisions that can cost us more than we reckoned.
Complacency increases the odds of making poor decisions. So does faith in certainties that aren't actually certain.
We're swimming in a sea of narrative envelopes, envelopes that distill complex dynamics into tidy packets that unify our internal emotional anchors and a simple story that makes sense of the world around us. These stories possess the power of mythology, something I explore in my book The Mythology of Progress.
Once our internal emotional anchors are bound to a story, we respond with strong emotions if the story is challenged. Rather than question our emotional stake in the story or the story's accuracy in tracking the real world, we double-down by becoming even more committed to the story.
Examples of narrative envelopes include neoliberalism, reshoring, America First, "other countries put tariffs on our goods, so we should put tariffs on their goods." All narrative envelopes share this trait: they're easy to understand abstractions. They appear to explain things but lack the foundations needed to make decisions about our own lives--what I call operative contexts.
Tariffs good, tariffs bad: how do either of these narrative envelopes help us make decisive changes of course in our own life? The answer is they don't. Simplified abstractions don't map the real world accurately enough to be useful guides to real-world decisions in our own lives.
Narrative envelopes come in many sizes and types. They all share another trait: they're attractive and compelling, much like ultra-processed snacks are attractive and compelling, bite-sized explanations that don't require much effort to consume.
Narrative envelopes are ultra-processed stories and ideas that go down easily and relieve the stress of uncertainty.
The question is: what's inside the envelope? Does the narrative help us make productive decisions in moments that demand decisive action in our own lives, or are they calming snacks, the equivalent of ultra-processed comfort food?
I've experienced recessions and financial turmoil of the sort that we're entering, and I've either made all the mistakes or witnessed all the mistakes in mis-reading the contexts that make our own lives much more difficult than was necessary.
My livelihood in those decades--construction--is the canary in the recession coalmine: the first thing everyone does is shelve any construction project that isn't already underway. In the go-go dot-com era,
I worked for a quantitative stock market analyst, and saw how complacency and narrative envelopes blindsided many as markets careened off the cliff in 2000 to 2003.
I've witnessed how the fiscal and monetary "saves" of the past 16 years have reinforced complacency and narrative envelopes even as they've ramped up the financial system's fragility. As Nassim Taleb noted in 2011 as the "saves" unleashed in 2009 kicked markets higher: "Complex systems that have artificially suppressed volatility become extremely fragile, while at the same time exhibiting no visible risks."
What's inside the envelope is messy, complex, inter-connected and in constant motion. There is no certainty or security, so we either close our eyes and hold tight to a narrative envelope or we embrace uncertainty and seek operative contexts that will help us navigate rough seas and poor visibility.
My recent post After the Tariff Earthquake casts a long shadow on the buy the dips in the Permanent Bull Market narrative. The question is: what if that strategy no longer works because conditions have changed?
As things unravel over the next few months, I'm going to be sharing key operative contexts with subscribers.
Let's start by assembling an operative context for the stock market, and financial markets in general. I understand that charts aren't for everyone, but I'm going to make it easy to follow along even if you don't care to look at the chart for more than a few seconds.
Here's the key stipulation: this is not investment advice or a prediction, and isn't intended to be investment advice or a prediction. What's presented here is context for the range of possible eventualities that might manifest in the next few years--nothing other than context.
Nobody knows what's going to happen, so all predictions boil down to educated guesses at best. I don't know what will happen, and neither does anyone else. All we can establish is what happened in the past and in what conditions. These don't conjure up a crystal ball, but they do suggest a range of possibilities that will help ground our decisions as events unfold.
1. Why the Stock Market Matters Even if 90% of Stocks Are Owned by the Top 10%.
One of the core dynamics of Hyper-Financialization is the concentration of stock ownership in the top 10%--a concentration that exceeds the Pareto Distribution of 80/20 (20% own 80% of assets) and the distribution of 4/64 (4% own 64% of assets): 90% of stocks are owned by the top 10%, and most of this ownership is concentrated in the top 5% and top 1%.
This concentration of ownership in the top 10% also holds for bonds, business equity and rental real estate.
One narrative holds that the stock market is now the economy, and if it falls, so does the economy. Another narrative holds the losses will mostly impact the top 10%.
The operative contexts in my view are the dominance of the spending and taxes paid by the top 10%, and the concentration of stock ownership in the total net worth of U.S. households.
The top 10% account for roughly 40% of all consumer spending, which isn't surprising given that they collect 40% of all income and own the majority of income-producing assets. This means the economy is heavily dependent on their discretionary spending: dining out, tourism, luxury goods, home improvements, new vehicles, etc.
The top 1% pay about 40% of all federal income taxes, and the top 10% pay around 70%. The vast majority of capital gains taxes are paid by the top 10%, as they own the assets that have increased in value.
Stocks have bubbled up to 40% of all household assets. This is near historical highs.
Should the stock market drop, the top 10% will experience the Reverse Wealth Effect: they will feel poorer, and as a result they will hesitate to borrow and spend money.
As stocks drop, capital gains taxes dry up. Since the economy is dependent on the top 10%'s spending and taxes, the inevitable result of a stock market decline is a self-reinforcing recession, as reduced spending and tax revenues trigger layoffs which further reduce spending and tax revenues.
2. Complacency.
Even as stocks have fallen dramatically, complacency has yet to give way to panic. The belief that stocks always rebound and the Federal Reserve will step in and "do whatever it takes" (a.k.a. The Fed Put) has been reinforced for the past 16 years.
The belief that stocks will inevitably rebound shortly leads to holding on as the market stair-steps down, increasing the eventual losses.
Chart courtesy of Mac10 @SuburbanDrone
3. Historical Analogs.
Analog charts--comparing the present market action to previous eras--are popular thought experiments, but they are better viewed as contexts rather than predictions. In other words, they show us what has happened in the past as a guide to the potential range of possibilities. The tricky part is assessing whether the conditions of the present are similar to those of the past.
Here is an analog chart of the 1929 stock market crash. Few see this as a possibility.
Here is an analog chart of the dot-com crash of 2000-2003, a three-year stair-step down in which the NASDAQ lost almost 80% of it peak value.
Here are two more charts of the NASDAQ. This one illustrates the symmetry of bubbles: they tend to decline in a mirror image of their ascent.
This chart shows that it took 16 years for the NASDAQ index to regain its 2000 peak. Adjusted for inflation, which eats away at the purchasing power of the dollar, it took 20 years to recover the valuation of the index at its peak in March 2000.
4. The Present.
This is a monthly chart of the S&P 500 (SPX). Monthly charts are long-term views of the market, and so they don't offer much guidance in day-to-day or even week-to-week trading. They are guides to longer term trends and provide historical context.
There are thousands of charts of the stock market. This is a very basic, very simple chart.
For example, look at the Covid Crash in early 2020. It doesn't look that fearsome on this chart, but it triggered a massive monetary policy response.
Even casual observers will note that when the MACD lines (moving average convergence-divergence) cross as they roll over, the market tends to continue down for an extended period. The MACD cross and declining RSI and Stochastics are strongly correlated to stock valuations declining for an extended period of time.
Chartists look for support levels where the market tends to consolidate. One such level is around 4,000 (the lower Bollinger Band) and around 3,000 (the 200-month moving average). A decline to 3,000 would represent a 50% decline in the SPX--not uncommon historically, but not something that's currently viewed as probable or even possible.
5. Bear Market Rallies
If the stock market is in a longer term decline phase, it's called a Bear Market. History offers numerous examples of sharp counter-trend rallies. A number of analysts are anticipating such a rally in the near future. Here is a chart forecasting a snapback rally.
Chart courtesy of The MacroPulse @TheMacroPulse
6. The 1970s Analog.
Many analysts are forecasting stagflation--sustained high inflation and slow / low growth. The 1970s are generally viewed as a stagflationary decade and therefore it serves as a possible analog for stagflationary eras.
Note that the stock market had big declines and rallies in the 1970s, and if we look at nominal prices, the market got close to or exceeded its February 1966 peak three times.
But adjusted for inflation--the red lines on the chart--the market lost two-thirds of its value. It did not regain its 1966 peak valuation when adjusted for inflation until the mid-1980s, roughly 20 years later.
This parallels what happened to the dot-com NASDAQ: it took 20 years to regain the inflation-adjusted peak of March 2000.
7. The Temptation.
Plug this into a spreadsheet: take $500 and buy options at $1 each and sell them for $2--a double. Now takes the proceeds--$1,000--and do the same. In 11 trades, the $500 balloons into $1,000,000. Wow--only 11 trades--how hard can that be?
Therein lies the temptation.
That's pretty risky. OK, then let's take 25% of each trade and buy a hedge--a bet against our primary trade. Now it takes 18 trades to turn $500 into $1,000,000. Why stop there? A few more trades and the $500 has become multi-millions of dollars.
That few manage 11 options trading doubles in a row speaks to the devilish difficulty of the task. But the temptation to try is embedded in human nature as a tropism for windfalls.
8. The Market is Rigged.
That the stock market is influenced by dark pools, central bank proxies, Wall Street firms and other forces is a given, but this doesn't seem to make markets predictable. Hot trading hands beat passive index funds every year, but the percentage of those beating the index funds drops to a handful after five years and to signal noise after ten years.
If any trading system worked with a high degree of consistency and accuracy, the percentage of managers beating the index funds every year for ten years running would be much higher.
One narrative holds that the best strategy in a rigged game is don't play. In terms of reducing risk in eras of market declines and stagflation, history supports the potential value of this strategy.
9. Conclusion.
No one can predict the future. No one can decide for us. We're on our own in an era of uncertainty and insecurity. The goal of operative contexts is to establish a range of possible outcomes based on history and then identify the core dynamics that are the primary influences in the present. With these in hand, we're more likely to make sound decisions and grasp the need for decisive action.
Perfection in decision-making isn't possible. The best we can hope for is to identify the operative contexts and nurture the humility and flexibility to change our minds as new evidence presents itself.
It may well be cold comfort, but continually re-assessed realistic appraisals are our best guides.
Highlights of the Blog
After the Tariff Earthquake 4/4/25
The Global Trade Game: Jokers Are Wild 4/2/25
Why the Global Recession Will be Deeper and Longer Than Pundits Anticipate 3/31/25
New Podcast:
The Coming Global Recession will be Longer and Deeper than Most Analysts Anticipate.
Best Thing That Happened To Me This Week
Thanks to readers' generous support of my work here, I was able to replace my 5-year old basketball, worn smooth by my solo dribbling/shooting, with a new basketball. Given the price may well rise in the future, I consider this a wise investment.
What's on the Book Shelf
The Boxer Rebellion and the Great Game in China: A History by David Silbey
From Left Field
NOTE TO NEW READERS: This list is not comprised of articles I agree with or that I judge to be correct or of the highest quality. It is representative of the content I find interesting as reflections of the current zeitgeist. The list is intended to be perused with an open, critical, occasionally amused mind.
Many links are behind paywalls. Most paywalled sites allow a few free articles per month if you register. It's the New Normal.
Something Bizarre Is Happening to People Who Use ChatGPT a Lot (via John D.)
People Don't Want to Go to Parties Anymore — and Other Signs the World is Coming to an End.
There's already a caregiver crisis. So who will take care of Mom if immigrant workers get deported? (via John F.)
Indian mural that spent decades on Norwegian hospital wall sells for record $13.8m.
The 4 Shortfall Nutrients Experts Worry Most About.
Fruits and vegetables aren’t as nutritious as they used to be. What happened?
The Epidemic Beneath The Surface: Disconnection, Discomfort, & The Death Of Resilience.
Meet the Beatles: Harris Dickinson, Joseph Quinn, Paul Mescal and Barry Keoghan to star as the Fab Four in Sam Mendes-directed films.
Gen Z Americans say the clothes in stores are a bad omen that we’re going into a recession.
Lesson learnt from the rise and fall of quantum radar research (via Michael M.)
Why These Japanese Cities are Returning to Nature (via John F.)
China’s Harsh Fiscal Winter (Richard M.)
"Becoming skillful at digesting our grief makes us a source of reassurance and stability for the wider community." Francis Weller (via David D.)
Thanks for reading--
charles |
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