Principles on which something is based are known to us as the concept of fundamentals. And the idea that, the core principles don’t change much, and therefore fundamentals are somehow God given, isn’t really a true assumption at all. Whether it’s our society or the financial markets. The core principles do change overtime, and the correlation that once existed, somehow disconnect. And those who try to gauge or asses the society or the markets using old principles / rules or fundamentals, do need to reassess their view.
In terms of market, the concept of fundamentals is based on perception unlike the laws of physics, so a sudden change in the perception and the overall market psychology can and will change the fundamentals of the economy relatively quickly, and therefore last quarter numbers, may end up being misleading as a guide. That’s the underlying issue. So it’s not easy for a human being to get the market right at all times. For example, a credit risk is in a way, a perception of the overall assessment of an underlying risk. And this assessment tends to be subjective by design.
Market behaviour and the overall market psychology are key driving force, when it comes to pricing, and sometimes markets don’t care much for fundamentals. You can call it an irrational market, but then the question you should also ask is, what is value ? Isn’t value measured or assessed using perception ?
Some in the market would argue that the US economy is fundamentally sound , and they will make that assumption based on their own understanding of the underlying data set. These data set over time were developed to capture or assess the well-being of an economy, and are now classified as fundamentals. In a way, the data sets are key ingredients of the process built to measure the health of the overall economy. But the process through which the data is gathered, relies heavily on the analysts using the old data as a reference, to make projections about the trajectory of travel. And sometimes the designed process fails to provide clarity. The various opinions then build the overall psychology of the market.
For a general discussion purposes, I have a selected a data set, to measure the overall net worth of the US population, as my way to understand the strength of the US economy in case of a crisis event. To be clear, the question I am asking is, will the consumer be able to support consumption if, there was a significant downturn. And what have I discovered ? Well! Around 15% of the US population has zero net worth and over 14% have negative net worth. So that’s roughly 29-30% of the population, who are simply incapable of supporting the economy, in the event of a crisis. And assuming there is a crisis then, the overall percentage of the population with negative to zero net worth increases significantly. It will probably be closer to 45-50%. This is on top of the overall US debt that is now moving closer $ 22 trillion, which is roughly over $ 2 trillion more than when Mr Trump took office. So yes, one may ask quite a valid question, and that is, how are the fundamentals of the US economy stronger based on the current overall debt level of the country ?
The saviour is the US Federal Reserve System and USD global status as a reserve currency. We could argue that it isn’t a prudent and sustainable business model, and that debt will continue. Taking it forward, if we do a real accounting then, the world is basically bankrupt, a few times over. Governments have obligations they can’t fund, so they keep doing creative financial engineering. And that’s understood by the market. In some instances especially the US, the size of the economy gives it an advantageous edge. Basically, US is too big to fail. So who are we kidding ? Also the key pillars supporting the financial system like Banks, run one of the worst business model. In a summation, we could say that, we have put together a fractured system with leaks everywhere, and then we worry about financial crises. As I see it, we will continue to move from one crisis to another, and there is no stopping that. Unless, we find a way to deconstruct the entire system, and the reconstruct with important design changes.
For clarity purpose, I am not projecting a large scale financial crisis type event , or a doomsday scenario for the US or the global economy in 2019. I am primarily trying to talk about, the overall structure of the economy, and at the same time, also referring to the behavioural aspects of the market where, you will see extremely exuberance, in other words bullish attitude, and then extreme pessimism, if some of the assumptions turn out to be inaccurate, creating periods of extreme volatility. And I believe, this can be avoided by changing the behavioural and psychological reactionary inputs that feeds volatility. You can create a crisis and also a recession if, for example more than 35% of the market participants felt it, even if it could have been avoided by making directional changes.
In a larger context, the fact is, even the laws of physics will eventually fail, because overtime the underlying holding the laws together will change. Humans wouldn’t have evolved, if they didn’t have the capacity to change, by changing their views, be it equal rights for all or giving animals their rights etc. All of this came about, when humans learnt to let their core principles change over time. And it is time, we change our view on how we see value, our society and the role of the economy, in our society at large.
Any idea that fails to create and capture value within a human being will end up being used to exploit a human being, and humans will then be enslaved to keep the idea sustainable. And that is just the basic fundamentals at play. Understandings markets also requires, a good understanding of humans, and why would it not ? Because it is the humans, who conceived the idea of a market and everything else with it.