It's Social Science not A Science

"One of the differences between the natural and the social sciences is that in the natural sciences, each succeeding generation stands upon the shoulders of those that have gone before, while in social sciences, each generation steps in the faces of its predecessors." - David Zeeman

I recently was provided an essay by George Soros from a friend of mine.  Now not everyone likes Mr. Soros but one thing is certain, he has a penchant for making money through investments.  The basis to his investment thesis is that there is no such thing as an efficient market and therefore there are always opportunities to make a return that exceeds what is deemed possible under the efficient market hypothesis.  Any businessman would agree with that as otherwise why start a business?

The reason he declares is simple.  Economics has attempted to create a science out of something that will always be a social science.  People will always have a will of their own therefore to argue that there is a rational answer to a market place is absurd.  First off what is rational?  What may appear completely rational to you seems completely mad to someone else.  Take the most basic example of a man and a woman.  Anyone who has been in any form of a long term relationship will attest that there are vast differences between the two schools of thought.  Which is rational?  The answer is that they both are to that individual but neither are to the other.  I constantly joke by saying that I am the most normal person that I know!

Now take this to the market place and then magnify this to the global economy.  Add to this recipe a large dose of political posturing, add in different religious ideologies, mix in the radical element and blend this together with numerous laws, taxes and military strength and viola you have a global souffle that is anything but efficient!

Looking at this then and convert that to the current economic crisis and you can quickly see why the risks to the current market run are massively skewed to the downside.  When the global engine is purring along (even with all of this craziness still intact) it is one thing, however with the struggles that Europe is facing it is sheer lunacy to think that the various politicians and central bankers of the world will fix the problem.  In all honesty a large part of the problem are the politicians who are so concerned about re-election that there does not seem to be one of them that is able to take a stand and put in place a decent economic reform package.

The European Union as it is currently known is on the verge of collapsing as there is no political unity on how to deal with the problems.  At the time of its creation it was assumed that over time the political agenda would match that of the economic agenda but it is clear that this has not happened.  Furthermore it is becoming more and more apparent that the leaders of the strong European economies are become more and more insular right when the opposite is required.  If this union collapses it will make the recent financial crisis seem tame.  In fact on Wednesday the FOMC came out with its updated statements and the main change that caught my eye was that they said the "Strains in global financial markets continue to pose significant downside risks to the economic outlook" while on March 13 the statement said that "Strains in global financial markets have eased, though they continue to pose significant downside risks to the economic outlook."  This means that while the United States is relatively well protected from a European meltdown it is not completely insulated how could it be?

In addition they reduce their GDP growth expectation to 2.2 percent from 2.5 percent a 12 percent haircut.  I firmly believe that based on the fiscal drag this will be cut down to 1.5 percent by year end.  These are not growth rates that will improve the job market any time soon.  You need GDP growth of more than 4 percent to suck up all the new entrants to the job market AND make a dent in the unemployment rate and even at that growth rate it will take more than 5 years to reach full employment.  High unemployment means that workers are not in a position of strength and therefore their earnings will languish while large corporations increase their profits.  However in the end companies need people to buy their products so this gain in margins will be short lived. 

In addition with lackluster GDP growth, companies are fighting to grow but the market is not therefore growth has to come at the expense of other company's market share.  So while some winners will reap huge rewards it will come at the expense of many other companies.  Just take a look at Apple's earnings versus all the other cellphone manufacturers to get the picture of how this economy skews the rewards into the hands of a few.  Hardly an efficient market and certainly hard to deliver excessive returns through a diverse portfolio of stocks. 

Alternatively secular bull markets occur when there is robust economic growth.  In this environment everyone can increase revenues due to the fact that the total market is expanding and can accommodate the growth of numerous businesses that compete in the same space.  Sure there will always be gaining and losing of market share but it is not as critical to survival as it is now and therefore it makes finding the winners far easier.

My hope is that the European problems do not spread across the globe and that somehow they can contain their problems and provide a sustainable solution that will give the global economy the leg up it needs.  Until such time the risks to the market far exceed the opportunity of future gains and I would advise a high level of caution for the moment.  Remember that hope is the worst of all four letter words in the investment world particularly when that hope rests in the hands of the politicians.