What a start of 2019 for cyclical stocks. The MSCI World Industrials Index (USD) is up 15% since the beginning of the year. A splendid recovery from the last quarter which saw what felt like flash crashes in October and December. Another 5% and the 2018 September level will be reached. Hallelujah!
It is important to recall that this positive trend started with a perfect volte-face from the Fed: Hawkish in December, dovish in January, noting that absolutely nothing changed in the world from a macroeconomic point of view in-between. This bizarre U.S. monetary policy episode has strengthened the view that the Fed – like the White House but hopefully for different reasons – is highly sensitive to bear market sentiment and is prepared to act as a circuit breaker in the financial markets. Thanks to this downside protection, equities have been benefiting from a strong regain in risk appetite. At some point it will have to be supported by macro-economic data, which may not happen before Q2.
At issue is the Fed’s lack of leadership. It keeps hiding behind a data dependency mantra and constantly adjusts its position to ephemeral circumstances. Granted, it does not have an easy task since faced with at least two challenges: First, the US economy is doing well whilst the rest of the world has been slowing down. As per our macro strategy team: ‘[The Fed] doesn’t want to prop the world up, but it doesn’t want the world to drag the US down either’; And second, inflation remains mysteriously low. But economic participants are right to expect a lot more from the Chairman of the Federal Reserve of the United States of America than a basic list of economic risk factors which anyone can draft and a pragmatic ‘Let us see what happens next’ followed by ‘I reserve the right to change my mind over the next moon cycle.’
The Fed’s troubling lack of leadership seems to be due to an absence of conviction, an ingredient which is required by leaders to provide their followers with some degree of certainty, thereby creating an environment prone to decision-making and action. True, conviction has its limitations. It can be born out of ideology and spur dogmatism. It can also easily be feigned by those unwilling or unable to go through a tedious conviction building process. Worse, according to the Dunning-Kruger effect, ‘People tend to hold overly favorable views of their abilities in many social and intellectual domains. […] People who are unskilled [...] suffer a dual burden: Not only do they reach erroneous conclusions and make unfortunate choices, but their incompetence robs them of the […] ability to realize it.’
Incompetence breeds conviction as much as conviction can conceal incompetence. This dangerous relationship must be highlighted but does not make conviction less relevant to leadership. As reminded by Peter Diamandis, leaders must make the future instead of following the present. Mr. Powell, please find some conviction and lead with it. The global economy and financial stability are at stake.