You slump onto the couch as you kick off your shoes. It’s been a long week and you realize the sigh has been leaking out of your lungs ever since you walked through the door. Fortunately, the remote is exactly where it should be—one couch cushion over. In seconds, you feel the cool plastic warming in your palm, the screen warming to the red “N” of Netflix.
It’s October. On the way into the neighborhood, you passed your neighbor—the one who’s already turned their home into a cobweb-covered haunted mansion replete with tombstones on the lawn and a giant spider climbing up the chimney. Maybe I’ll do that next year, you think, knowing you’ll be lucky to carve a pumpkin by the 31st. Still, the mood is set, Halloween is in the air and you settle on watching something spooky.
Before long, the teenagers in the B-flick you picked are partying at a lake house with no adults in sight. The kids hear a noise outside. “Where’s Fluffy?” the bubbly cheerleader says to the high school quarterback when she realizes the family dog has gone missing. “Probably ran off with a werewolf,” the class clown says in his mockingly macabre voice. Then he walks out the door to look for the dog, entering the darkened forest alone.
Moments later, the kids shudder at a scream from the woods and it’s then that you get up to make yourself some popcorn because even though you’ve never seen the film before, you already know what’s going to happen next. The teens will split up. The girl-next-door will look for the class clown in the forest. The now not-so-bubbly cheerleader will go to the toolshed. The bookishly handsome nerd will go to the boathouse. The quarterback, saying he’s going to look for a phone, will slink into the basement to hide. And of course, with logic and reason thrown out the window, bad things start to happen.
You know this is what will happen because that’s what always happens to teens in horror flicks. These are the tropes of the horror genre. We expect and recognize them because the situations and outcomes are predictable. And moviemakers know certain tropes attract moviegoers which is always a recipe for success.
Beyond books and movies, tropes exist elsewhere. And some professions, like financial services, are even built on them. Recognizable patterns don’t allow us to predict the future, but we can follow them to deliver highly probable outcomes. And because markets, industries and economies all move in cycles, we can know certain things about what’s likely to happen in the future, just by studying the past.
* chart courtesy of multpl.com
The 1970s were marked by high inflation, a spiraling and disastrous condition for an economy. Americans then watched as the cost of everything from gas to food to housing to healthcare rose faster than their incomes. And when businesses could not pass along the rising costs of their supplies to consumers, they had a choice—lay off workers or go bankrupt. Most chose the former. Unemployment rose. Businesses produced fewer goods. There were more shortages, rising prices and even higher inflation; the vicious cycle continued.
We are in a similar situation today. To their credit, Washington politicians acted quickly when Covid hit, sending stimulus checks to counter lost wages from quarantined workers. But stimulus can only ever be a short-term solution. Very specific conditions must exist for government spending to spark a slumping economy and unfortunately, those conditions are not present today. Even if businesses could find more workers, they have supply chain issues preventing them from getting the materials they need to make more of whatever it is they sell. Just like the 70s, when there is too little to go around, prices and inflation rise.
Tropes be true, we know what the inflation remedy is. We’ve seen this story unfold before and we also know what the likely outcome will be. The Fed needs to pull money out of the economy to strengthen the dollar. Interest rates will rise (back to a more normal level in today’s case) and the economy will probably slow (a bit) as businesses adjust.
The good news is that these are not in the 70s. Inflation is rising but it is still manageable and it hasn’t been a problem for long. Businesses should adjust quickly to a stronger dollar and higher interest rates so any slowness in the economy is likely to be short-lived. As long as Americans rejoin the workforce, unemployment will go down, spending will increase and the economy will start growing again.
The better news is the quality companies we own—profitable businesses with sustainable competitive advantages and experienced management teams—are the companies that tend to do well in environments such as these. That doesn’t mean they don’t lose value in a slumping economy. But quality is always attractive to investors, and quality companies tend to recover faster. Owning a group of them puts an investor in a very strong position.
We expect teens in horror movies to use poor judgment. After all, they don’t have the benefit of a fully functioning frontal lobe. Of course, neither do politicians. But unlike their teenage counterparts, we can count on our elected representatives to fulfill another, greater trope—they are self-preservationists, always doing whatever it takes to keep their jobs. If the prospect of incurring some short-term discomfort eliminates the risk we have a 70s-style unemployment problem, many politicians will take it, allowing the economy to reset and paving the way for Americans to go back to work. In the meantime, we are well-positioned to weather the conditions ahead.
Travis Raish, CFA