Eternal now and constant change
Mihail Stoyanov
Helping adventurous investors find asymmetric ideas in obscure market niches| Ask me about mining, energy, and shipping| Get your five asymmetric ideas for 2025.
We live in the eternal now. The unbearable flow of information turns time into an endless moment. A moment anticipating the next dopamine shot induced by other bits of information.
The pursuit of dopamine high, triggered by the "new" information, ?squeezes our perception of time - everything happens in the eternal now. The past, the present, and the future are compressed into one point.
The point at which we receive the next piece of data. We do not remember the previous one, and we do not know what the next one is – the eternal now has engulfed us... until the dopamine high ends and the finger starts flicking on the screen again in desperate search of the next shot.
Residing in the eternal now comes with a steep price. We become increasingly impatient and reactive. We are unable to wait even until tomorrow; we want everything now. Instead of being proactive knowledge seekers, we turn into passive information consumers. Impatience and reactivity guarantee future success... but for those who control the information flow.
Let's add the financial markets to this eclectic mix. To summarize, we blend impatience, reactivity, and investing. What could go wrong?
The market paradigm is changing once again. One reason for this is the combination of impatience and reactivity resulting from our inability to manage information. The latter is due to our bodies not being designed to process such an enormous data influx. Technologies are constantly evolving, while our bodies are not.
That deficiency is transferred to the markets. We always look for the best investment. The flow of information constantly brings us new ideas, claiming to be the next top bet. We feel like kids in a candy store. We want crypto, uranium, biotech, bonds, real estate, or whatever the media are pitching us.
This behavior is deeply ingrained in us. We as humans are always inclined to seek the new because we assume that what we have is not the best. However, new technologies further distort this perception.
What brings together new technologies, information, and the market paradigm?
Epsilon
Let's start with some theory. Academics identify one parameter as a statistical error. This is the letter Epsilon, which, according to the Capital Asset Pricing Model (CAPM) in the equation for ROI, is the difference between expected and realized returns. In other words, it's a rounding error we can safely ignore.
We may ignore it, but at our own risk. When the market paradigm shifts, epsilon has such an impact that alpha, and beta appear as statistical errors.
Epsilon is a parameter describing the shift in the market paradigm. The latter depends on the following:
The market paradigm is never static, and we are on the verge of another change. It will be driven by technological development and central bank policies. Regulatory laws will retain their importance but carry less weight than the other two.
In summary, the main pillars of the new market paradigm are:
We start with technologies - whether they serve us or we serve them. They are tools, and it depends only on us which of the two roles we choose.
Technologies
Think about the progress over the last five decades. The amount of information generated and the speed of data exchange increases non-linearly with each decade. However, our biochemistry has yet to adapt to overwhelming information. We are the same people as we were 100 years ago or even 2500 years ago.
We live in a black-and-white world of hunger and satiety, life and death, warm and cold. Our bodies have yet to adapt to the abundance of information. It is becoming increasingly challenging to manage the flow of information. It controls us; when we unwittingly submit to it, we become impatient and reactive.
Every bit of information is an external stimulus that provokes us to act. The well-known algorithm – motivation, action, consequence – is triggered multiple times. Every media article, tweet, or Facebook post is a new stimulus. We switch madly between posts without extracting any tangible value. We are like the Red Queen, who moves so fast that she stands still.
Unlike our behavior, technologies are constantly evolving. The incredible number of stimuli (information) paralyzes us, making us impatient and reactive. All this ultimately transfers to the markets. Our ability to control the flow of information directly affects the investment decisions we make.
Unrestricted access to information and financial markets, combined with our reactivity and impatience, forms an unexpectedly profitable mixture... for brokerage firms.
Following the above reasoning, I arrive at several conclusions:
Impatient and reactive market participants will lead to:
The above points conclude markets will become even more efficient. They will come as close as possible to the theoretical postulate of the Efficient market hypothesis (EMH) – a large number of participants having (almost) equal access to the same information.
Equal access to information and markets cannot practically be achieved, but as we can see, it can be approached with great proximity. An approximation large enough to make alpha extraction increasingly challenging.
Due to the broad and (almost) equal access to financial markets and information, we have relatively efficient markets. This means we have growing numbers of market participants making more trades.
However, something is still missing—the fuel that drives the markets. That fuel is liquidity, depending on central bank policy. That policy, in turn, follows the goals set by central bankers (inflation, employment, and growth).
The Central Bank – goals and tools
The second factor defining the new market paradigm is the secular inflation cycle. We have a demographic crisis in developed economies (excluding the US) and geopolitical fragmentation. A declining population means fewer candidates to fill the same number of jobs. We have a tightening labor supply and constant demand from the other side (a relatively stable number of employment). The result is rising wages and decreasing unemployment, which is inflationary.
Regarding the second element – military conflicts – war and inflation go hand in hand. War requires already scarce resources due to the supply destruction cycle, the Green Deal, and emerging countries like India. Short supply and substantially increased demand inevitably lead to rising commodity prices. Simply put, inflation is not going anywhere and will stay long.
The third factor contributing to inflation is the persistent spread of supply destruction in the commodity sector. Underinvestment and absurd political decisions have made the supply of any commodities so vulnerable. The imbalance between demand and supply is already too apparent and will worsen in the following years.
Declining demographics + increased number of conflicts + commodities supply destruction = secular inflation
How does this relate to the market paradigm? The central bank's task is to control the following macroeconomic variables:
Central banks have tools at their disposal. They aim to control the demand side, i.e., the money supply, to achieve the desired goals. The tools are:
Since we are in a new inflationary cycle, Central Banks have no choice but to control inflation by reducing liquidity through one of the three tools. Interest rates closely follow inflation – when the latter rises, so will interest rates, and vice versa.
The era of cheap and abundant money is over. Interest rates inevitably will affect liquidity to tame demand. Remember, the goal is to control inflation.
The Hypothesis
Markets are entering a new regime due to the following factors:
The new market paradigm comes with new, well-forgotten old rules. The past decade has spoiled us with easy money. We became like Pavlov's dog—QE is the stimulus, and buy-the-dip is the response. This period ended in 2022. I am not saying there will be no new bull markets, but they will be harder to play. Moreover, we will need a new set of tools to extract Alpha.
To summarize:
To illustrate my conclusions, I use an analogy from the book Blue Ocean Strategy. Businesses operate in the red or blue oceans.
The middle of the curve is the Red Ocean, where most participants are. They hold positions for up to six months. At both ends of the curve is the Blue Ocean, where participants hold positions for too short (seconds) or long (over a year) periods.
The Red Ocean is a place of fierce competition. A vast number of participants are fighting for a limited amount of Alpha. It is easy to enter this ocean because the inertia of the crowd carries us along. Market participants believe there is enough Alpha for everyone in the Red Ocean.
The blue ocean is the opposite - a few participants pursuing the same limited amount of Alpha. Entering the Blue Sea is problematic because it is too unpopular. The lack of broad interest leads to the conclusion that no Alpha exists. The reality shows otherwise - Alpha is hiding outside the mass focus.
The upcoming market paradigm shift is more common than it seems. It reminds us that the past has the habit of rhyming itself. We have had periods of high interest rates and will have them again. The ZIRP era is an exception, not a rule.
The new critical variable is technology. It has democratized access to information and financial markets. More and more people are participating in the markets and consuming more data.
The only constant variable is us. Our biochemistry is unable to adapt to the continuous information flow. We become increasingly impatient and reactive. We will execute a growing number of trades for shorter periods. The outcome is a market regime with new, well-forgotten old rules. They can be successfully compressed into the following phrase:
Money moves from the impatient and unprepared to the patient and prepared.
If you are interested in niche ideas, fixed-income securities, and options, consider TheOldEconomy's Institutional subscription plan. Let’s hop on a call to discuss esoteric ideas, investing tools, and risk management.