Bob Homan: ‘This time is different’
This column was originally written in Dutch. This is an English translation.
By Bob Homan, CIO ING Investment Office
In view of the major changes the economy has gone through in recent years, the cry ‘this time it's different’ rings truer more often than in the past.
Anyone professionally active in the investment world knows the difference between causation and correlation. Well ahead, one more time then: correlation is simply the relationship between two things, while causality indicates that one thing directly affects another. Therefore, correlation is always necessary for causation, while causation is not necessary for correlation.
With this definition in mind, I marvel at the facile historical comparisons that economists, strategists and investors sometimes trot out for their expectations regarding the further course of bond and equity markets. I marvel because causality is regularly absent from the correlations outlined. In the past, that causality may have been there, but now - if you think about it - it is very different.
A few examples: ‘After the first interest rate cut, a recession is bound to follow after a year (or at least two).’ Yes, if interest rate cuts are initiated because the economy is slipping, then yes. This time is different.
Or, another nice one: ‘If unemployment rises by more than half a per cent in three months, a recession (the Sahm rule) follows’. Fine, but if unemployment rises due to an increased supply of workers, that's really different from when layoffs actually occur on a large scale.
Another one: ‘Growth stocks underperform value stocks when interest rates rise.’ Not necessarily, as we saw in the first half of this year. Many growth companies are hardly leveraged anymore. Indeed, they often have so much cash on their balance sheets that higher interest rates can be beneficial.
Of course, it is fine to include historical knowledge in your analyses and forecasts, but be wary of reckless comparisons. First, find out carefully whether causality still exists. And if it doesn't, forget it, and find something else.
‘This time is different’ counts as a dangerous statement in finance. Given the major changes that the economy and markets have gone through in recent years, this cry rings true more often than in the past. So goes my prediction.