Wednesday, January 18, 2012

- Return Of The Confidence Fairy

The "confidence fairy" is the amiably disparaging term my co-worker uses to describe the cause of my 2012 optimism.

We’re both Macro guys, but he tends to rely on the published economic statistics a little more than I do. I’ve told him that I think there is a roughly 15% to 18% "Romney premium" available in stock market valuations for 2012. And as the election begins to look negative for Obama, people will begin to price it in. But since the origin of this number isn’t apparent in the current economic statistics, he tells me that I’m betting on the confidence fairy.

I have to say, in some respects, he’s right. I absolutely agree that the economic statistics don’t show the origin of my optimism. But I think that’s so because the numbers deal with aggregate statistics and the aggregation hides some of the interesting detail. Let me explain.

The economy has not universally gone off a cliff. Some areas of the economy have been much more seriously impacted than others. Housing and construction have been hurt badly as has finance and Healthcare R&D, while things like accounting, regulatory compliance, and manufacturing automation really have not. But the economic statistics that are published tend to smooth out all those differences and talk about the economy only in the aggregate.

But what that masks is that when the emphasis of an economy changes to “risk taking” from “risk avoiding”, it tends to do so from the bottom of the deepest troughs first. Those are the areas where prices have been allowed to fall the most, and will therefore attract the most daring risk takers. So when the mindset changes, it’s the really devastated areas that will be most effected. I believe this will have an out-sized impact on the statistics, even though it isn’t clear from looking at only the averages.

Or to put it another way, right now we have tepid economic growth, but the growth only looks tepid because (as an example) some areas are growing at 3% and some areas are shrinking at 2% giving us a net of +1%. If the economy improves only in those areas where it’s currently shrinking, even if it’s only to bring them back to "flat", then the net effect will be to dramatically improve the aggregate number; much more so than would be apparent by looking at the individual data sets.

I’m exaggerating my point a little to make the point clear to non financial folk, but that is the essence the claim I’m making. The parts of the economy which have been doing worst are the parts which will improve the most through new risk taking, and the overall impact on the broader economy will be larger than expected.

I believe it will also have an outsized impact on how people 'feel' about the economy, which is the more traditional description of things like 'consumer confidence' statistics. The free market has always naturally caused money to flow to those areas which most desperately need it – that’s what happens when you allow prices to float instead being fixed by regulation. So when people take risks, they do so by taking their capital to the areas where it's needed the most. Unlike a government directed economy, it's a naturally efficient system.

None of this is to say that as Obama’s reelection prospects dim it’s straight back to the go-go 90’s. We still have enormous economic challenges to face down. But I figure that as Obama's re-election looks less likely, there is about a 15% to 18% gain that can be had simply because an irrational economic outlook is no longer being offered by our government. That’s what Obama and the far left have advocated – a completely irrational economic plan that is designed to achieve the opposite of what it ostensibly intends. Take that away, and it's like the moment when you stop banging your head against the wall. Fear of the risk takers will begin to subside, and the free market will begin responding as it should again.

Am I mistaken about the number? I dunno... maybe. But if it turns out to be 8% or 11% premium, will anybody be willing to call me out and out wrong? I doubt it. I think the confidence fairy wants to come back, and the real 'hope' for America, is getting rid of Obama and the far left. Then we can begin looking forward again, instead of continuing to cope with our 'managed decline'.

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