Long and Variable Lags

Milton Friedman, the conservative University of Chicago economist and Nobel Prize winner, started talking about long and variable lags in the late 1950s. He described that the process central banks follow to aid or retard economic activity by adjusting interest rates up or down is fraught with timing issues. When interest rates rise, they will eventually show their effect, but very little change occurs immediately.

Think of economic activity as a fully laden oil tanker, when the brakes are applied it takes miles and miles before the slow down to a standstill finally occurs. The knack therefore is not to brake too late or the tanker will run aground.

There is an emerging fear that central banks should have applied the brakes months ago.

We have watched valuations of our portfolios ebb and flow over summer in typical fashion. Veteran investors have experience of lower return summer months and higher return winter months. But suddenly September is back to haunt us once more as the month of the year which typically gives the lowest returns. This year it’s negative returns so far, taking our valuations down to the lowest point since April.

The US Federal Reserve has maintained the confidence of market participants so far as a delivery of a “Soft Landing” seemed to be achievable. In turn this soft landing was anticipated here in the UK and across Europe. Last October in “Have Interest Rates Peaked?” I said;

The real indicator for central banks is the level of unemployment. So far the rises have been low, but at some point the trickle picks up speed and then it positively floods higher if central banks send rates too high and put companies out of business. The level of un-employment itself is a lagging indicator. The numbers aren’t reported until it is too late and those individuals are placed on “the dole” or whatever it is called today.

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2024 Begins

Happy New Year!

Before we look ahead to this new year, let’s look back at what we all went through in 2023. It was really quite a lot!

January

  • China opens borders, ending zero-COVID policy.
  • Almost three million people were infected with COVID-19 over the Christmas period
  • Microsoft invests $10B into OpenAI, extending their partnership.
  • UK Inflation starts the year at 10.5%

February

  • Chinese “Spy Balloon” drifts over the Americas.
  • The original 4 day Russian invasion of Ukraine has now lasted 365 days.
  • Russia suspends participation in nuclear arma reduction treaty.
  • The Bank of England raise interest rates from 3.5% to 4%.
  • US interest rates rise to 4.75%
  • A milder winter across Europe ensures gas reserves do not run out as feared.
  • An estimated 475,000 workers go on strike, the single biggest day of industrial action for more than a decade, 

March

  • Silicon Valley Bank and other regional US banks collapse causing banking turmoil.
  • The Bank of England announces that the UK arm of Silicon Valley Bank is to enter insolvency, following the demise of its US parent, the largest banking collapse since the 2007/8 financial crisis. Many UK tech startups are prevented from accessing cash to pay staff
  • UBS buys collapsing Credit Suisse for $3.2B
  • BOE base rate rises to 4.25%
  • US interest rates reach 5%
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Decisions, decisions

We use our brains to think.

Everyone understands that, there’s nothing new or ground-breaking in the above statement. Except it seems evolution hard-wired our brains to do anything and everything we possibly could do instead of thinking. The brain is less of a thinking machine – more a thinking avoidance machine. How so?

Our brain requires oodles of energy to function. Our grey matter uses 20-25% of our total calories burnt every day. So in our former hunter-gather times, when Homo Sapiens went days and days without food, our brains were trained to run in eco-mode. Less decision time = more down time = less calorific requirement. Less thinking, more thinking avoidance.

These days, understanding how our brain works has become increasingly important when it comes to many challenges including investing. We process so much information in a day that our brains cannot think about it all. It goes caveman more often than we realise

How does our brain do this? The brain creates short-cuts. Instead of considering the problem and burning more precious calories, it efficiently creates an answer based on our memory of past experiences. Before it ponders the new problem it simply jumps to an answer it previously had. It has efficiently therefore avoided thinking.

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