In the world of algorithmic trading, one minute is already a long term. For the human trader, the short term ends on Friday evening and the following week is shrouded in fog, because anything can happen on the weekend. The average investor is an unprincipled man who takes home a small profit right away if this is fast and rewarding and transforms everything on which it loses into a strategic choice. The institutional investor, for his part, is mentally more structured but knows that farsightedness (required by common sense and by the supervisory authorities, who would like him to be oriented towards long horizons) is difficult to reconcile with the habit of some clients to move their their money from one manager to another depending on the results of the last quarter or month.
So woe to be early, better be late. Who in 2006 had exhibited a prudent portfolio (free of shares and full of safe long-term bonds) would have lost at least half of the customers (who, remaining invested in shares, would have lost more than half of their money two years later). The institutional investor spends his days glued to the monitors and at night he sleeps with one eye open that incessantly follows the Asian markets. His agility would seem infinite, but it's actually infinite when it's least needed. In decisive moments, at the peak or at the bottom of a cycle, his hands are tied by the Value at Risk, that risk measurement system which requires the portfolio to be reduced when volatility is maximum (typically at the extremes of the cycle).
It should also be remembered that while buying well at the lows is relatively simple (bid-ask spreads are wide, but the sellers are found), selling well at highs is a matter of luck. If you are a moment late in a market that is starting to collapse and you have so much to sell because you are big, you seriously risk not finding buyers and further lowering the prices of what you want to get rid of. For this reason, especially for those who handle a lot of money or have illiquid investments, it makes perfect sense to ask ourselves today whether it is better to focus on the probable recovery of the markets in this 2018 (with possible extension to the first quarter of 2019) or whether it is instead appropriate to tune in on the long waves and prepare in time for the next bear market, which could arrive later, perhaps as early as 2019 or 2020. Is it better to risk being short-sighted or risk being farsighted?
Before trying to answer, however, we must discuss the two hypotheses, the positive one for this year and the negative one for the medium term. Let's start with 2018, which had to live late autumn physiological correction that did not exist in 2017 because blocked by expectations on American tax reform. Well, we had the reform and it was even better than expected. But the celebration lasted a year and led to a 25 percent appreciation in the New York Stock Exchange, a beautiful cherry on eight years of equity rally. The climax of the festivities coincided with a global wave of positive surprises from the real economy in a phase of still innocent inflation. After a triumphal and volatility-free 2017, there would have been a correction anyway.
If we add to this the recovery of inflation, the rise in interest rates and a series of macro disappointments almost everywhere (unavoidable since we started from the hypothesis of perfection) the correction has gained full legitimacy. But that's not enough, because new complications have arisen in recent weeks. We are talking about the rising US budget deficit, the disenchantment with technology as an engine of perpetual growth, the winds of trade warfare and the winds of outright war in the Middle East. In the face of these significant obstacles, the markets have actually performed quite well and there is no shortage of those who say that the correction that started at the end of January still needs a more serious wave of fear than the ones we have seen so far before we can finally talk of markets cleaned up and ready to recover.
We'll see if this last shrug will really be needed, but at the moment we can already say that many of the fears that have gone through the correction have proved to be excessive and premature. Inflation is certainly on the rise, but not as fast as in January (driven by the euphoria following the tax cut). Long-term rates, after the initial fears, have even dropped. Congress's reluctance to attack the technology and Zuckerberg's good performance have allayed immediate fears of penalizing the industry. The easing Chinese measures on the trade front have led to thinking of a two-level confrontation, the first, very aggressive, for American and Chinese public opinion and the second, concrete and operational, in behind-the-scenes negotiations.
Syria remains, where we start from a casus belli, a chemical attack a few days before the American withdrawal, which promises a response where the political objectives are not clear (Assad? Russia? Iran?). This will probably be a strong but limited response, but complications cannot be completely ruled out. In any case, to truly end the correction, the markets will wait for the story to end. Having priced in January perfection and a surprisingly large number of problems in this correction, markets will be ready for a more balanced stance and a slow, cautious recovery over the summer and autumn. The November lessons in America will be a delicate passage, but the new Congress will take office at the end of January and 2018, if earnings confirm expectations, will be able to conclude with a positive sign.
Later, however, a series of structural issues will begin to come home to roost. Even if the intention of central banks is to tolerate a certain amount of inflation, rates will continue to rise. Everyone will try to stay behind the curve and keep real rates close to zero, but the possibility of going too high will become increasingly real. Liquidity, for its part, will continue to decline and for debt securities there will be more supply and less demand. We must also keep an eye on the American consumer, who cannot spend much more unless they go into negative savings, while Europe will have to continue to digest the rise in the euro and China will complete its cleaning job after the big boost to spending in 2017 and before the even bigger one that promises to take place in 2021, the centenary of the party.
Note that a bear market doesn't always need a recession or a financial crash. If you're from great heights, weak growth and the prospect of flat earnings to be discounted to ever-rising rates may be enough, especially if in a shrinking liquidity environment. Let us therefore enjoy, hoping that there will be, the recovery that promises to take place over the next few months, but let us begin to enter into an order of ideas whereby we sell on the upside more than we buy on the downside, giving priority, when we sell, to less liquid stocks. Unless, of course, you decide not to worry about the bear market to come (and which won't be a repeat of 2008) and really look to the long term.
