It’s a minefield out there

8. IV 2016

Despite record corporate profits we are not seeing a commensurate rebound in demand. Behind this disconnect lies continued trend of consolidation, growing concentration of ownership and general focus on increasing the monopolistic power (i.e. giving up commitment to competition). Backed by strong shareholder mentality and strict fiscal discipline, the profits are effectively being hoarded. Anyone who has recently traveled on one of the major airlines (coach, of course) would have no difficulties connecting the dots: Even as the price of fuel (one of main expenses) collapsed, little of that benefit was passed on to consumers (or airline employees). The airlines story is paradigmatic as it captures rather accurately the mechanism behind the US economic slowdown.

Concentration, which has become one of the main corporate mantras, is contagious and self-reinforcing. Its onset in one sector triggers a wave of consolidation in another, which ultimately results in non-competitive markets and disrupts the mechanism behind the invisible hand, which in turn means that consumers end up paying too much for goods and services while their wages continue to stagnate. This is the territory where standard macroeconomic models are of little help — the existing economic paradigms no longer seem to be relevant to the problems we are actually facing. As a consequence, people are gradually giving up general macro frameworks as a way of facing the markets, and tactical (and high frequency) trading is taking over.

These developments come hardly as a surprise. They are seen as an advanced stage of a long running process. Long-term has become too complex and eludes consistent modeling and forecastability. This has been the biggest lesson of the last 6-7 years — the spectacular failure of economic models to forecast the future year after year borders on cognitive paradox. This has given way to short term mindset and focus. However, with the shrinking of horizons and with the use of technology and communications, short-term has become so fast that it leaves no room for human intervention. So, all efforts are aimed at designing automated (black-box) platforms capable of competing in an ever accelerating environment. In this way, responsibility has not been eliminated. It has been merely averted from say forecasting to the design stage.

There is a reason for a mild concern due to this state of affairs. Black box platforms can only function in the presence of a firm low-frequency backbone, either macro or structurally stable platforms are necessary to set the trends which black boxes use as a reference – without a backbone they become non-adaptive and disoriented. In the markets with backbone, new information typically triggers first order repositioning of big asset allocators which induces distortions due to flows and trading signals for the rest of the market. Without the backbone,  black boxes only talk to each other. There is no informational value in the market flows (garbage-in, garbage-out) and subsequent reactions have no informational content or value either. The system becomes highly sensitive to initial conditions: Even in the presence of perfect foresight where the present might determine the future, approximate present does not approximately determine the future (this is the essence of chaotic systems). As long as there is no disturbance of the market, some kind of stability could be maintained. However, relatively benign shocks are capable of causing unforeseeable changes.

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