I love science fiction (sci-fi) for two reasons. First, there’s all the brainstorming about what future technologies have in store for us humans. I love learning about new technology and wondering what the future holds – and if science fiction is any indication of our economic future. The bigger reason I love sci-fi, though, is because of us humans.
Technology can change radically, but human emotion and behavior always remains constant. In the new movie “Ready Player One,” for instance, there are new gadgets and completely new virtual worlds to explore. However, there’s still human fear and greed, hope and desperation, sadness and joy. All the emotions that make us human are still present, and that makes science fiction oddly comforting for me. As we explore how humans will behave in futuristic worlds with new gadgets, we find that the human spirit endures because of the complex set of emotions we all possess. Human behavior is the reassuring constant in sci-fi stories.
Relative differences vs. absolute measures
In many ways, the investment markets are similar to science fiction. Events change, technology changes, economies change—but human behavior is a constant. When we look at the future of investment markets through that lens, we can draw some comfort. While we cannot predict the short-term movement of markets, we do have a lot of insight about what the long-term path and outcome will look and feel like.
Volatility has been uncannily low during the last two years. The past few weeks have seen a return of volatility back to more normal levels. This feels like a huge increase in financial unpredictability, but it’s really just the market getting back to normal.
One of the interesting aspects about the human brain is that we are very good at categorizing things by relative differences, not by absolute measures. For instance, when we meet a new person, we log lots of information about them, including whether they are taller or shorter in height than we are. That’s an example of relative difference. We don’t think, “Oh that guy is exactly 5’10” (an absolute measure).
In Star Trek, Captain Kirk categorizes Spock as slightly taller than he is. That’s because Kirk is human and that’s how he assesses another person—by comparison to himself. However, Spock knows that James T. Kirk is precisely 5 feet 10 inches tall because he’s a very exacting Vulcan.
As typical humans, then, we feel that market volatility is extremely high because relative to what we’ve seen recently, volatility is now much higher. However, Spock would tell us that if we examine historical measures, the more accurate assessment is that volatility is actually around normal levels right now.
Assessing the issues of tariffs and trade wars
Another relativity example: Tariffs and the idea of a trade war feels out of control to us right now because we have not experienced either of them in a long time. In actuality, the current proposed tariffs are relatively small by both economic standards and historical perspectives. They only seem scary because they are somewhat unfamiliar.
While we at RegentAtlantic believe that tariffs are destructive to both the global and U.S. economy, the scale at which they are currently proposed has more to do with political posturing than actual policy. The markets do not like posturing, though, and the relative shock of this has caused an increase in volatility.
In their current form, we do not see a great cause for concern because of the absolute low levels of tariffs. However, we are more concerned about the potential for trade wars to escalate. We will continue to monitor that situation.
The pros and cons of too much optimism
Science fiction showcases another quirk of human behavior: over-optimism. Humans tend to be naturally overly optimistic. That feature really helps us when we are striving to climb a mountain, develop a new invention or start a business. If we humans were more realistic, we would probably never start out on any great quests!
The movie “Back to the Future” was filmed more than 30 years ago. The future we are living in now is already beyond the end date depicted in the movie. However, I still don’t have a flying hoverboard. While we’re at it, I still haven’t met Hal from “2001: A Space Odyssey,” either. Sci-fi writers are human so they tend to be overly optimistic about how quickly the future will actually arrive.
Because market participants are also human, they, too, tend to be overly optimistic. For example, markets are usually overly optimistic about predicting future profits, especially when it comes to new technologies. We get enamored with the technology and misestimate factors like the risks involved, development problems or how quickly the competition can catch up.
Over the past seven years, the market has been more enamored with the promise of future unproven profits than real current profits. Investors have been willing to overpay for prospective virtual earnings and have largely ignored stocks that are rewarding investors now with current earnings. This factor has caused growth-style investing to outperform value investing since 2010.
The return of value investing
Growth and value styles cycle in and out of favor, and sometimes these cycles can last many years. Over the last 90 years, the longest time period for which we have data, value has actually outperformed growth by more than 2% a year. That’s why RegentAtlantic has long favored value investing: 2% a year can make a huge difference in wealth. Over the last few weeks, we have seen value start to outperform growth. We believe this could be an inflection point that starts a long cycle during which value outperforms growth.
As you can tell, I love science fiction and thinking about what is possible in the future. Just like in the movie “Ready Player One,” though, we all eventually need to step out of interesting virtual worlds and live in the real world. Similarly, I believe that stocks cannot forever live in a world of virtual profits. At some point, real profits always matter the most. This is especially true during periods of crisis. Real profits form a firm foundation, while virtual profits may never materialize to support your financial plan.
Happy Spring! Please contact your Wealth Advisor or me with any questions or concerns.
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