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System Reset

‘Rationalization’ is defined as a process whereby a typically controversial behavior is justified and explained by an individual in a seemingly rational or logical manner to avoid the true explanation and to make it acceptable. For example, a person buys an expensive car and then tells its entourage that its old car had become unsafe; Or a person evades paying taxes and then rationalizes it by arguing that the government wastes money.

Let’s seek to apply this psychoanalytical concept to the current business environment. In a paper published this week,(1) our strategists rely on more than six years of data to demonstrate what has been suspected for some time: Both the market and macro-economic cycles have significantly changed since the Great Financial Crisis. More specifically, the analysis of time series shows that:

  • Market cycles feature a shorter duration, smaller amplitude but higher ‘speed’ which makes them more violent

  • The economic cycle has shortened and become more pronounced in high frequencies, but milder over longer horizons

Trends have become ephemeral. Nothing drives anything. Consequently, it has become exceedingly challenging for economic actors to act with conviction. In fact, conviction is possibly one of the Great Recession’s highest profile casualties.

Unable to rely upon much of it, decision-makers have had to make bigger bets than in the past. However, decisions cannot be presented as bets to stakeholders. Therefore, decision-makers must go through a comprehensive rationalization process to transform bets into carefully thought through decisions and to market them as such to their constituencies.

Consider the Fed. Recent behavior suggests that it has not been immune to the generalized shortage of conviction. Instead of keeping its rates unchanged this week, it could have decided to make an alternative bet by raising them by 1/4%. It could have easily come up with a robust, well-crafted explanation supporting this move. An alternative version of the press release which could have been published by the Fed on Wednesday under this alternative scenario can be find below to illustrate the point.

Simply put, in the absence of a clear consensus narrative, all leaders and leading institutions, like the Fed, have the ability to make up stories with a view to rationalizing their bets. ‘Not that there is anything wrong with that!’ as Jerry Seinfeld would say. Rationalization actually serves as an important defense mechanism which in our case protects our system and its institutions. But fewer and fewer people are being fooled. As a result, ‘decisions’ made and the rationale underpinning them fail to send the signals required to give the economy and the markets a direction. The trendsetting power of leaders is dwindling.

How do we break out of this pattern? Something extraordinary needs to happen: An event or occurrence, such as a technological breakthrough, an exceptionally long period without any exogenous shocks, or a large exogenous shock(2) which acts as a defibrillator to reset the system at its core and gives conviction and, with it, power, back to leaders.

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