Travel sickness
In both of these cases adjustments in certain asset prices (oil and RMB), though unpredictable in timing, are taking us to better places as investors. I submit three reasons why investors are uncomfortable with the journey.
l Reflexivity: the behaviour of financial markets is strongly affecting the way investors feel about the underlying real world at this juncture. Usually the inverse relationship – where investor perceptions of the real world determine market performance – is the dominant one. However, during times of economic complexity and high emotion, investors put much less weight on real world analysis and take their cue from the market.
l Excessive market short-termism: relative price adjustments incur short-term pain for long-term gain, but markets are focused, perhaps more than ever, on the short term.
l Risk as volatility: volatility is an estimate of risk, not a measurement of risk. This is a monumentally underappreciated point. As such, many investors do not supplement the consideration of volatility with a deep analysis of underlying real world events. Sharply falling oil prices, and sharp changes in other prices affected by this, by definition increase volatility. However, can it really be true that a world in which the global energy supply is largely controlled by a small number of political leaders, some of whom are running very poor quality and unreliable regimes, is less risky than a world with a diversified and localised energy supply?
It is important to respect these behavioural factors and their tendency to exacerbate market routs. However, such overreaction to fundamentals is one of the most credible arguments for active management. Ultimately, it presents buying opportunities. This time, we believe, is no different. LW
