No Free lunch lasts forever

Volatility will make a comeback--someday

Photo by Sam Dan Truong on Unsplash

Hello,

Welcome to Known Unknowns: a newsletter that is bullish on the bullish market—but there’s no free lunch.

Let’s talk about this market

It’s crazy. Apparently Nvidia is now worth more than all of Manhattan real estate. And the recent past is even crazier. I made this chart for my Bloomberg column, and, other than the pandemic, in the last 15 years, the S&P just went up and went up steadily. It has been years of high returns and low volatility. It was truly a special time for markets—and if you believe stock prices today, the best is yet to come.

Some of that belief comes from our own recency bias. Many people also seem to believe rates will go back to zero and inflation will gently fall back to sub 2%. Why? Because that’s what happened the last 15 years or so. It’s easy to believe the recent past is the natural order of things or that the most recent equilibrium is a stable one. And if you believe that, it is intellectually consistent to presume the stock market will repeat the last 15 years too.

But of course, anyone with any knowledge of financial data or macroeconomics knows that’s nonsense. Fifteen years of data is nothing, and no market lasts forever. Equilibriums aren’t that stable once a shock comes along or structural conditions change. Financial data is noisy for a reason.

A better argument for high stock prices, especially the Magnificent 7’s performance, is that the global economy is about to undergo another radical transformation on par with the Industrial Revolution in the form of AI. I think that’s a bit much; I reckon it is the second phase of the tech revolution. But whatever you want to call it or how important you think it is, it does mean the potential for higher growth and profits to be made. Any firm that is poised to be a leader in this space will become very, very valuable—like the Standard Oil or railroads of the day.

But any big transformation of the economy is inherently volatile and introduces uncertainty. There will be many false starts. Overinvestment in some areas, underinvestment in others. This all means more volatility, especially for AI-related stocks. Also consider markets are much more concentrated, which means less diversification. That does not always mean more risk if they are big, mature firms. There have been periods of concentration before, and things were fine volatility-wise. But the concentration here is in an immature industry, which means more risk.

 If AI pans out, that means decades of some growth but also some pretty big blowups along the way. I would not take the low-volatility environment we have today as any comfort about the future.

Tipping

Presidential candidate Trump has an idea to make tipped income tax-free. This is a terrible idea. Making certain kinds of compensation tax-advantaged (even when well-intentioned) just creates all sorts of distortions. That’s true even if you think it is a type of compensation we should (arguably) have more of, like retirement savings or health insurance premiums. But tipped income is not something we should want more of. In the low end of the market, it means less predictability for tipped workers. On the high end, it means servers are paid 80% more than chefs, even though being a chef takes more skills and training.

Tipping in America is not about rewarding service. It is obligatory and effectively means 20% to 25% of restaurant revenue must go toward servers rather than letting the owner distribute revenue as they see fit. This is not something to be encouraged. And in the high-inflation environment, it is already creeping into more transactions. If it were tax-free, it would be even more pervasive. You’d have to tip the person (or machine) who rings up your groceries or even your therapist.

The whole idea is just bad economics.

Texas stock exchange

The state of Texas is opening its own stock exchange. Other states have tried and failed, but perhaps this will be what finally breaks the New York monopoly on stock trading. I doubt it will happen anytime soon, but it is important to realize New York is no longer the center of finance anyhow. More finance jobs are in Texas, and that’s been true for a while.

Will an exchange accelerate this trend? Maybe Elon Musk will list Tesla on it; that could be a big deal. I think the bigger issue is technology means you don’t have to be in any one place. Creative clusters still are important, but they are more distributed.

I am not sure what that means for productivity. It could be as big a deal as AI.

The Fed

I went on The Indicator to talk about the dot plot. I don’t see the point of it anymore. The Fed does not know what’s going to happen any better than the rest of us. So why make promises they probably can’t keep anyhow? I am all for transparency, but not if it undermines credibility, which is the whole point of this exercise.

Until next time, Pension Geeks!

Allison