Peter St Onge

Okay, the picture is Japan, but it’s what I imagine a roller-coaster in Liberia probably looks like right about now.

And what a roller-coaster it’s been for markets. After months of zombie-marching to new highs, in the past month the main US indices are down about 7%, while Europe is down even harder. If you’re long the market, it’s been painful. If you’re short, you’re probalby in Aruba right now trying not to spill your Mai Tai.

What’s going on? Is it the end of the world? Will we have to live in the car? Will Jimmy get his braces?

Everybody knows that wars are won with strategy and tactics. The strategy is the big picture — do we land in Italy or Normandy? Do we shell Fort Sumter? And tactics are the little things — take this hill, bomb that building, torture the guy over there.

In investing, of course, the strategy is long-view and the tactics are day-to-day trading. Long-view is where economics can help, but trading tactics are probably closer to pure psychology, with a heap of intuitive feel that one earns by literally years of “ass-in-chair” (more formally, Hayekian tacit knowledge).

When I ran the hedge fund, one thing I learned is that I’m very good at big-picture trends, and that I’m really quite awful as a trader. My timing is so bad you could probably make a lot of money selling subscriptions to my daily trades — so nobody makes them. Or maybe so they take the other side.

So why did I do so well as a fund manager? Because 90% of investing is strategy. If you see the big picture, you know the trends. You can consistently trade on the worst possible day of that month, and you’ll do perfectly fine so long as you’ve got the big trends correct.

So, with that, what is the big picture?

First, the US economy is actually quite healthy. Credit is going in the right places — to business and not layabout consumers. Credit distress is very low (bad loans, bankruptcies). Rates are low and inflation is benign. GDP is healthy. Jobs are so-so, but that’s probably more about welfare than existence of jobs.

Of course, it’s all a sham and won’t last and etc. The prosperity is bought by the Fed by ravishing savers. All true. But that’s not the question: the question is whether the economy will be healthy over the next 3-to-6 months. And I think it most likely will be, barring some natural or manmade disaster.

Why are the markets falling, then? That brings us to the second part, tactics. Economies do their thing, and asset prices do theirs. The two correlate pretty well, but not perfectly. For example, the 1987 crash was during a healthy economy. It wasn’t the economy’s fault, blame marginally-sane traders.

So at least part of October’s doldrums aren’t coming from the economy — maybe there’s a psychological dread or something touchy-feely about Ebola.

The one part that is economic, though, is those crazy foreigners. Europe and China are both headed clearly into a slowdown or recession, and Japan’s doing it’s darnedest to join the recession party. Collectively, those 3 economies make up most of world GDP, and close to half of US firms’ profits. Toss in knock-on countries like Thailand or Brazil, whose economies depend on Europe, China and Japan, and it turns into a real party.

My best guess, this drama is coming partly from non-economic factors, and party it’s importing others countries’ troubles.

So what’s next? Barring some escalation from the news (Ebola, ISIS, Ukraine, Hong Kong), my best guess is that Europe and Japan flirt with recession, China slows. These trim US profits, dragging stock markets down. They won’t themselves cause a US recession; that probably doesn’t come until inflation crops up, which is delayed if foreigners do have their recessions.

In the next few months I’d expect trimmer returns than we’ve been getting the past few years, but I wouldn’t bail on markets just yet. Keep an eye on the big 3 foreigners — Europe, China, Japan — and keep an eye on inflation. If the foreigners fall then expect stock declines, and if inflation rears up you’ve got a year to get into cash or gold and ride out the next recession.

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