Gregory (Scotland Yard detective): “Is there any other point to which you would wish to draw my attention?”
Holmes: “To the curious incident of the dog in the night-time.”
Gregory: “The dog did nothing in the night-time.”
Holmes: “That was the curious incident.”
-From “Silver Blaze,” a short story in The Memoirs of Sherlock Holmes
In last month’s article, we discussed the Real Risk that investors should be paying attention to. This month, we ponder the mystery of “The Bear that Doesn’t Growl.”
The Absence of Expected Facts
Back in 1892, Sir Arthur Conan Doyle published a collection of short stories called: The Memoirs of Sherlock Holmes. As is elementary knowledge to any fan of Detective Holmes, one of the best-known stories in this collection is Silver Blaze, a mystery about the disappearance of a famous racehorse – and the murder of his trainer – the night before a big race. Sherlock Holmes solves the mystery in part by recognizing that none of his interview subjects from his investigation recalled that they had heard any barking from the watchdog during the night of the murder.
This story has come to be known as the “Curious Incident of the Dog in the Night-Time” and has spawned several other books and plays over the years since it was published.
The fact that the dog did not bark when you would expect it to while a crime was being committed was the key piece of evidence for Holmes to solve the mystery. This clue led Homes to the conclusion that the evildoer was not a stranger to the dog but instead was someone the dog recognized and thus would not cause him to bark. Holmes drew a conclusion from the fact that barking did not occur, which can be referred to as a “negative fact” or an expected fact that is curiously absent from the record.
The moral of the story is that in some circumstances, when you expect certain facts will be demonstrated — like the barking of a watchdog during the commission of a crime — the absence of those expected facts can have significant meaning.
Elementary, My Dear Watson!
Everybody knows that conditions are pretty challenging these days in the financial markets and on the geopolitical scene. In the words of Detective Holmes, this observation is “Elementary”!
Geopolitically, it seems that important shifts are occurring in the global balance of power that has for so long favored America. In the last year, the war in Ukraine has continued and appears to be morphing into a dangerous proxy war between Russia and the West. An increasingly militant China continues to threaten hostilities against Taiwan. And it is difficult to imagine how Israel will continue to stand by and allow Iran to complete the development of nuclear weapons.
Here in the U.S., we appear to be careening toward another bitterly partisan presidential election.
Likewise, the stability of the world’s financial system seems to be more fragile than it has been at any time since the Financial Crisis of 2008-09. This year has brought multiple high-profile bank failures in the U.S., the demise of a major global financial institution in Credit Suisse, and the continuing habit of developed countries increasing their debt significantly faster than their economies are growing. The American economy is still experiencing unacceptable inflation, and in response to that, the Federal Reserve has executed the sharpest interest rate hike in American history, even while recent bank failures make it increasingly difficult to raise interest rates to fight inflation.
Since March of 2022, the “Federal Funds” short-term interest rate has been increased a whopping 10 times from a rate of .25 to the current range of 5%-5.25%, which is the largest and fastest rate spike in history. In response to these rate increases, both equity and bond markets have declined, corporate earnings have struggled, several banks have failed, commercial real estate has wobbled, and many investors have begun to worry about the stability of the U.S. Dollar.
In short, as the media will no doubt constantly remind us, we should expect that the total chaos of the last few years is not going away and that, in fact, new and even nastier surprises can’t be ruled out. The “Expected Facts” that should be demonstrated in this circumstance is that the world should be experiencing a sharp Bear Market in stocks.
The Mystery of the Bear that Would Not Growl
Which brings us to the curious incident of the bear who would not growl.
At the moment, the global equity market is not experiencing a sharp Bear Market at all. In fact, the S&P 500 hit a low point of 3,577 over six months ago, back on October 12th of 2022, and today stands more than 15% higher at a level of 4,130. Given the litany of disasters described above, the equity market should be hitting new lows — but it is not. Of course, it may still do so. But for now, we have a significant “absence of expected facts,” which may have some important meaning.
Perhaps a clue to the “Mystery of the Bear that Would Not Growl” can be found in this headline from CNBC back on May 3rd, when the Federal Reserve last hiked interest rates:
The Federal Reserve approved its 10th interest rate increase in just a little over a year and dropped a tentative hint that the current tightening cycle is at an end. (Emphasis Added)
It doesn’t take a detective to know that historically, stocks usually recover at the end of cycles during which the Federal Reserve has been hiking interest rates. The only mystery which remains is, will they, in fact, end this current cycle soon?
Having a Plan
The very best investors have a disciplined approach to making portfolio decisions and always stick to their plans, no matter what the rest of the world is doing. They are able to live through the peaks of euphoria, as well as the depths of terror, with a healthy understanding that a well-designed written investment and financial plan will get them through both.