Thursday, September 24, 2015

Economics - cycles

Despite strong evidence to the contrary, we humans seem to display a tendency to anchor our expectations on recent history and extrapolate recent trends far forward into the future. It seems part of the evolved human psyche. Recent examples include expecting high oil prices (above $100/bbl) to become the new normal; food scarcity due to strong Chinese demand meaning that we'll have to get used to permanently high grocery prices; high gold prices being with us forever as people lose faith in government printed money; permanently low volatility in financial assets due to a Great Moderation. What people forget is that the world moves in a non-linear manner with multiple feedback mechanisms that act as self-correcting triggers. Policy may get in the way of corrections, allowing imbalances to build up to dangerous levels before they revert, but sooner or later the correction occurs. It's then a question of depth, extent and potential over-reaction. From an investment perspective, it would be interesting to analyse the speed of market responses to price movements e.g. farmers can switch crops from one year to the next but it can take years for the oil and gas industry to respond to high energy prices with meaty capital expenditure projects, although the ability to turn production off is much quicker.

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