The canary in a coal mine

Retirement systems are so interesting because what happens to them is always the canary in a coal mine for the larger economy. They reflect everything about our ability to save, redistribute, plan, and deal with risk.

The canary in a coal mine
Capital Thinking | The canary in a coal mine

Capital Thinking  •  Issue #1117  •  View online

The virtue bubble is about to pop.

I don’t like to use the word bubble regarding financial markets, I am too much of an efficient markets believer to think that such a thing is possible.

After all, all if prices reflect information, and information tells you that an asset price will go up, it is reasonable to keep buying, regardless of whether it is based on fundamentals—even if prices will someday go down.

That is if you are into active trading (which I am not). However, I am tempted to use the B-word when it comes to the virtue economy.

-Allison Schrager

We can't have nice things

Unless we are willing to pay for it

Allison Schrager | Known Unknowns:

The virtue economy is not just ESG investing; it is also choosing where you work and what you buy based on who you think is virtuous.

It may have been a bubble because during good times because we told ourselves that we could make virtuous economic choices and not pay anything for it. ESG funds were even sold as outperforming regular (sin-filled) funds.

And for a while that seemed to be true. When everyone was buying up ESG, it outperformed—at least until it didn’t this spring when markets fell.

The true test of any asset class is how it performs in adverse market conditions, and ESGs are under-performing now. And they should.

That is not a value judgement, it is just math. If you put a constraint on your investment choices, then you should earn less than an unconstrained portfolio.

Meanwhile, in a high-inflation environment (8.6%!), only buying from virtuous vendors leaves less scope for substitution, which is your best inflation hedge. If the labor market tightens, maybe you can’t afford to be so fussy about where you work.

I think that this is a bubble that needs to pop. ESG funds are facing more scrutiny for “greenwashing” or not picking the right companies. However, this is a feature rather than a bug.

What makes a company virtuous is arbitrary, and everyone has different values. Oil companies are some of the biggest investors in renewables. Does that make them good or evil?

Interrogating your hamburger buns for moral virtue takes time and is terribly inefficient.

Just buy what you want, work for who pays you the most, and buy sin-filled stocks. Then, give all that extra money to charity.

When will interest rates go back down?

Not anytime time soon, I think. Like many financial macroeconomists, I always thought that long-term interest rates mean revert, which means that I have been waiting for 40 years for them to go up (well, not really that long—I was not that interested in such things in elementary school).

The ten year hit 3%. Is this the start of rates reverting to the mean, and the last 40 years were just one long cycle?

Yes and no. I think that structural changes, such as the demand for dollar assets from more globalization, low inflation, regulation, and the explicit Fed put on bonds, lowered the rate’s natural level.

Therefore, although we are not going back to the 1980s, rates may still rise, foreigners are less excited about US debt, and well, inflation is both high and unpredictable.

Although I am not one to make market calls, I would not take out an adjustable-rate mortgage in the hope that mortgage rates will go back down to 2.7%.

Policy risk

Now that inflation is officially out of control, there is much speculation that there will be a recession within a year. Many people think that it is already here.

I think that this is a fair assessment, even if other aspects of the economy look good on paper.

If you are much poorer because you can’t afford to keep up with rising prices, then it is a recession to you.

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We can’t have nice things
Unless we are willing to pay for it

*Featured post photo by Joshua J. Cotten on Unsplash