Guest Column: Entrenched pessimism, not naïve optimism, is the trap for investors to avoid in 2023
Optimism in 2023
Charlie Parker, Director, Albemarle Street Partners
To remain optimistic about the world during years like 2022 was a challenge for those with even the sunniest of dispositions. Soaring prices, striking unions, creaking public services, rising taxes, spiralling interest rates and a dark comedy of political chaos have left us doubting whether the United Kingdom can ever recover. Added to this, all the signs are that before this is over the rich world will have to pass through some form of recession.
As investors, this presents us with a key challenge. At times like this the commentariat works hard to sound as negative as possible. There is a simple reason for this as Morgan Housel writes in the Psychology of Money: ‘Pessimism holds a special place in our hearts. Pessimism isn’t just more common than optimism. It sounds smarter. It’s intellectually captivating, and its’ paid more attention to than optimism, which is often viewed as being oblivious to risk.’
Housel points out that our desire to be pessimistic is at its route an evolutionary process. In the investment world, if we meet someone who tells us about a great stock idea we may half listen to the insight. However, if we meet someone who tells us about a stock we already own, and tells us it will crash, we listen completely – even if the track record of the speaker is dubious. Our brains are programmed to light up at the sight of risk.
Perhaps we also gain some succour from the gallows humour of pooling our collective misery during tough times. As an economic historian Deidre McCloskey writes: ‘For reasons I have never understood, people like to hear that the world is going to hell.’
After major economic problems, even extremely pessimistic views can become mainstream thinking. For example, at the height of the credit crisis in 2009 a front- page article in the Wall Street Journal quite openly suggested the break-up of the United States of America. Yet history teaches us pessimism is rarely right in the long-term. The late social historian Hans Rosling, author of global best-seller Factfulness, who describes himself not as an ‘optimist’ but a ‘probabilist’ asks us how we can possibly be so miserable about the world when in the past 30 years the number of people in real poverty has halved, even as the population has exploded. He found presenting his research to global leaders such as those at the World Economic Forum, that he could show a world that according to any basic statistical measures like poverty, infant mortality or deaths from natural disasters was generally improving. Yet his audience, however sophisticated, had walked into the room believing in their gut that the world was getting worse.
The current wave of pessimism in the world is built around the belief that inflation will become endemic, that nothing will shift it, it will metastasize into our society and change the shape of life for a whole generation of people – much as it did in the 1970s.
We believe this is mistaken. That period of time- whilst having similarities to today, occurred because of a prolonged era running from the end of World War II to 1979 when the rich world was launching what US President Lyndon Johnson called ‘an unconditional war on poverty’. Principally this was to reward the ‘greatest generation’ who had returned from World War II demanding proper healthcare and housing. His war on poverty meant that huge government spending, compounded by an oil crisis, sent prices soaring unchecked for years. It took a new Federal Reserve chair in Paul Volcker in 1979 to stamp this inflation out. He only achieved it by shifting entirely the focus of public policy. Rather than unconditionally tackling poverty, he unconditionally attacked inflation. It worked. Inflation fell rapidly and, in comparison to history has stayed low for the past 40 years. Yet it came at a cost – he caused a recession which by the early 1980s had sent 10% of the American workforce into the unemployment queues.
This central observation about inflation is the most crucial one. The only real way to rid ourselves of it is to allow a sharp slowdown in economic growth, even a recession. No politician wants to say this for obvious reasons, but it is the sober lesson of history. The current chair of the Federal Reserve Jay Powell, a long-time acolyte of Volcker, clearly does understand it and has taken the necessary action to bring it about. Yet the good news about recessions is that they end. They are not a cause for long-term pessimism, whilst they are horrible for many people, they do pass. Once they are upon us and inflation is falling then governments can move in to help. As investors, we look through recessions. Our goal is simply to measure how bad they will be not to become despondent about their existence. For this reason, stockmarkets are often rising sharply by the time the recession actually lands.
But are there more profound forces in the world that could give us cause for a longer-term more evidence-based pessimism about the future? There are serious economists who think there are. Following the Global Financial Crisis eminent figures such as former US Secretary of the Treasury Larry Summers, the author of the book Capital by Thomas Piketty and the New York Times’ columnist Paul Krugman claimed the world was heading for what they called ‘secular stagnation’.
Their argument was that the rapid economic growth of the past 100 years occurred because of an unusual period of rapid technological improvement that massively improved the productivity of society. They argue that today’s innovations do not match up to the innovations of previous years for this productivity gain. For example, they talk about the enormous gain of indoor plumbing and the washing machine releasing women into the workforce and claim that the gains for example of the internet are not so great.
Whilst this more pessimistic view of the future is well-grounded and driven by the best economic minds of their generation it has a big problem. Each and every time the world suffers a major economic crisis, people appear to tell us that this time the recovery will be sub-standard, that this time it’s different. Unknowingly they are predictable actors in the play, appearing at the same time after each crisis and making the same argument.
The Bank of Italy analysed the past 100 years and found that each time things have got tough, people have made this argument. Each time they have been proved wrong. But why? The authors Patrizio Pagano and Massimo Sbracia found that the reason the world keeps getting better, the reason over the long- term economies keep getting more productive is not because of any huge breakthrough in technology. Instead, it is because the doomsayers consistently underestimate the power of making small improvements to technology and processes that already exist within society.
The leading economists of the world in other words, consistently underestimate the power of ordinary people working each day to make the world just a little bit better. As yet; no pandemic, inflation surge, even World War, has proved a powerful enough force to stop the world getting better – because everyone is trying.
As investors therefore, working to grow our client’s wealth for the long-term, the real trap is not naïve optimism but entrenched pessimism that could rob our investors of the opportunities that will exist as we emerge from this crisis.