One day, two young fish are swimming along…
They happen upon an older fish heading in the opposite direction. As the older fish approaches, he says, “Morning, boys. How’s the water?”
The two young fish swim on. Eventually, one turns to the other and says, “What the hell is water?”
This story was originally delivered in a speech by American novelist David Foster Wallace in 2005.
It’s an interesting insight. But what does this mean for us as investors?
The American Heritage Dictionary defines the word “paradigm” as:
A set of assumptions, concepts, values, and practices that constitutes a way of viewing reality for the community that shares them, especially in an intellectual discipline.
Put even more simply, a paradigm is the set of “rules” that govern our perception of reality. It’s our beliefs, our framework for understanding the universe.
To borrow a phrase from the writer Ben Hunt, it’s the “common knowledge,” the things that everybody knows that everybody knows.
But paradigms can be tricky things…
When they stick around long enough, we imagine them to be permanent. We can’t imagine any other way. Like the two young fish in the story, we are swimming through water we don’t even know is there.
And that can be a problem.
Because − despite what we might believe − paradigms change. Our worldview is thrown off-kilter. Everything we believe, everything we think we know, is proven wrong.
And it is my firm belief that such a paradigm shift is coming for the markets. In fact, it’s already here.
Three Assumptions You Need to Change
How would we define the investing paradigm of the last several decades? At a very high level, I would argue it consisted of three basic assumptions:
Low inflation and the expectation of low inflation.
Easily available credit and the continued expansion of credit.
The belief that central banks could always “save us.”
If we look back at the recent decades, we find these assumptions have generally held true.
From 1994 until 2020, year-over-year inflation stayed under control. In that time span, it was only in 2007 that consumer prices increased at a yearly rate above 4%.
Until very recently, the Federal Reserve’s main concern with inflation was that it was too low.
Assumption No. 2 is also correct.
Apart from financial panics like we experienced in 2008–09, credit has been readily available.
Made possible by ultra-low rates, this financing gave rise to high-tech startups that took the world by storm and made many fortunes in the process.
As for the third assumption…
In the wake of the 2008 Financial Crisis, central banks cut rates to essentially zero and left them there for years. But they didn’t stop there.
The Fed − and other central banks − began buying mortgage-backed securities and Treasurys on the open market.
This forced down the rates on bonds and flooded the banking sector with liquidity. We know this today as “quantitative easing” (QE).
We will leave it to others to debate the merit of such actions. But what’s important to understand is that, for decades, central banks have been implicitly messaging investors one thing: We’ve got your back.
Taken together, I would loosely define these basic assumptions as the investing paradigm we have all been living through for the past three decades. This is our “water.”
There’s just one problem: It’s all coming to an end.
The Old Paradigm Is Over
As I write to you, official readings of inflation remain at elevated levels. And due to “adjustments” in the way the Consumer Price Index is calculated, many economists believe that the peak “real” rate of inflation for the average consumer is closer to 15% annualized.
It is my firm belief that the Fed will not conquer inflation easily or quickly. This will be a prolonged battled that stretches on for years.
And credit is also tightening. Data from the Fed itself confirms as much.
Below, we’ll see data from the St. Louis Fed tracking the net percentage of banks tightening their lending standards.
In other words, they’re making it harder to borrow.
What you should notice is that the figure is rapidly approaching levels not seen since the COVID crash and − before that − the Great Financial Crisis.
That’s a huge problem for an economy that depends on a continued expansion of credit simply to operate.
But what about the central banks? Surely, investors assume, the Fed will be able to pull off another miracle. That’s the hope.
But I seriously doubt it.
The Fed finds itself between a rock and a hard place.
On one side, there is the crippling levels of inflation. But on the other, there is the unavoidable recession/depression coming in the months ahead. And that assumes we’re not already in one.
The Fed’s usual move of cutting rates will only exacerbate the inflation problem.
And if the Fed hikes rates further to combat inflation − even if it maintains rates at current levels − the central bank risks sparking more liquidity crunches and bank runs.
To put it simply: Nobody is coming to save us.
The old paradigm is dead. Investors that do not understand this will be woefully unprepared for what comes next. I suspect many could be utterly wiped out.
But there is a way to prepare for − and profit from − this changing world order.
New Paradigm Research
I graduated from Harvard Business School in 1972. Shortly after, I began work with Morgan Stanley & Co. In other words, I’ve invested through markets before the “old paradigm” I mentioned above took hold.
I’ve seen what ugly markets can do to a portfolio. From April 1971 to April 1982, the real (inflation-adjusted) return from the Dow was negative 62%. Buy-and-hold investors were destroyed.
But that doesn’t mean there weren’t profit opportunities.
For instance, in August of 1987, I predicted the notorious “Black Monday” crash. One client who followed my research later told me that her traders were able to turn $100,000 into $13 million by following my predictions.
I believe we’re heading back to that world. We’re entering a “new paradigm.” And in this new world, we will have to invest very differently than we have these past 30 years.
I would like to show you how it can be done…
I invite you to join me today at 10 a.m. ET.
At that time, I’ll reveal my latest prediction for this new paradigm, including the exact day I believe it will kick off. And of course, I’ll share what investors should do to prepare.
You can reserve your seat by clicking right here.
I hope to see you there.
Editor, New Paradigm Research