Well, that’s a surprise! Contrary to all expectations, the US economy grew 3.1% in 2023, compared to 0.7% in 2022. The stock market continues the rally from 2023-end – the S&P500 recently hit all-time highs, powered by the so-called ‘Magnificent Seven’ BigTech stocks.

I remember the OG Stanley Druckenmiller telling CNBC he’d be stunned if a recession didn’t happen in 2023. Going against all such predictions and in the face of interest rates being at 23-year highs, the fact that the economy is poised for a soft landing has got me thinking about market expectations and their bearing on how things eventually play out.

I have a working theory on this – based on observation, I believe that when the market has too much of consensus expectations around a negative event, it somehow reduces the probability and/or the intensity of that negative event.

Let’s play out some thought experiments on this…

#1 Inflation

In 2022, the market (including the Fed) had a consensus expectation that inflation would remain sticky and continue to rapidly increase, thus explaining the steepest rate hikes in history.

However, given this widespread expectation, both consumers and businesses likely started to proactively tighten their belts, managing demand, reducing costs, and improving productivity to increase supply. The combined impact of this proactive action perhaps brought down inflation much faster than the Market expected?

#2 Recession

The market expected that given the steepness of rate hikes and how that has played out in the past, a recession was imminent. This widespread expectation likely prompted both individuals and businesses to proactively become more fiscally prudent, improve their productivity, and essentially, start doing more with less. These efforts perhaps contributed to avoiding a recession and creating a soft landing instead?

#3 Google

Post the launch of ChatGPT in Nov’22, the market held a consensus expectation that Google’s search business would be rendered irrelevant in the new chat-based AI paradigm. The stock hit a 52-week low in early’23, with the likes of Brad Gerstner (Altimeter) proclaiming that Google’s monopoly was over.

However, the rise of OpenAI and negative market expectations likely woke up Google from its slumber, forcing the management to focus, play its hands in AI (Bard, investment in Anthropic), and do some tough belt-tightening (unprecedented series of layoffs and org. flattening from a company that has been considered as a safe haven for employment over the last 15 years).

#4 Crypto

With the SBF scam, and the SEC cracking down on Coinbase and Binance, many thought that the US is completely closed for business in Crypto. In fact, I remember this being explicitly mentioned in one of the All-In Podcast episodes. However, less than a year after these events, the US has approved Bitcoin ETFs, bringing crypto to the mainstream as a legit asset class (read my post “Bitcoin ETFs and The Challenges of Digital Gold“). As it turns out, the SEC crackdowns were not to shut down Crypto but to clean it up so that it could come into the mainstream.

Connecting the dots…

It seems like widespread negative expectations have a tendency to catalyze a chain of mitigating actions by various stakeholders. In this era of social media, this happens even faster than expected. Perhaps, the human behavior of “loss aversion” creates a sense of urgency, precipitating tough decisions and better execution.

Modeling future scenarios…

Let’s use this mental model to run a few more thought experiments on things the market has negative expectations on right now.

#1 AI taking away jobs

The market has a widespread narrative that AI will end up taking away most knowledge jobs as we know them. However, workers are already aware of this shift and are working to counter it eg. upskilling themselves, starting side hustles to create financial buffer etc.

In parallel, universities are already realizing that their coursework might be outdated soon. They are frantically working to upgrade content, get more AI practitioners involved, and introduce coursework that requires “building” as a way to learn.

Enterprises too, are keenly aware of how a post-AI world will require a different set of skills and are already starting to re-train and upskill employees. Further, in less than a year of ChatGPT’s launch, govts. across the world are proactively thinking through the socio-economic ramifications of AI, including how to stay nationally competitive as well as re-distribute wealth in an increasingly unequal world.

Contrary to current market expectations, all this could create a positive surprise on productivity and job creation in an AI-driven world.

#2 China

The market has overwhelmingly negative expectations of China, including how Xi is taking the country back to its communist roots, the population is de-growing and it’s getting geo-politically discarded by the West.

However, this multitude of adversities could actually rally the CCP to undertake path-breaking reforms, the general population to become more productive, and the country generally coming together more effectively to come out of this mess. Again, more likelihood of a positive surprise from here on.

#3 San Francisco

The market consensus is that San Francisco is America’s Gotham City, a decaying region that the next generation of talent is unlikely to choose to live in.

However, these dire circumstances are already putting massive pressure on local political leaders, forcing corporate leaders like Marc Benioff to speak up against how the city is being run, large budget deficits bringing administrative incompetence to the fore, and the city’s residents finally deciding to speak up and drive political change. I won’t be surprised that all this drives a positive change in SF faster than anyone expects.

#4 Commercial real estate

I watched the recent 60 Minutes episode that talked about how commercial real estate is getting decimated in cities like NY, with even marquee buildings at all-time-high vacancy rates. The market has a consensus expectation that work will become overwhelmingly remote and the concept of offices will cease to exist.

However, this rock-bottom could perhaps force developers and landlords to innovate and re-think what the concept of an “office” should be going forward. And, even force cities to upgrade regulations on how urban buildings can be converted to mixed-use. Irrespective of technology, the human need to connect and collaborate with others, as well as be outdoors to refresh and re-energize, remains the same.

Closing thoughts…

Of course, these are just probabilistic thought experiments. As a disciple of Howard Marks, I am always wary of forecasting. However, this working theory that consensus negative expectations often end up seeing a surprise on the positive, is a useful mental model. It helps in not getting overly carried away with the crowd’s narrative, thinking through the likelihood of various scenarios playing out, and positioning yourself optimally.

Subscribe

to my weekly newsletter where in addition to my long-form posts, I will also share a weekly recap of all my social posts & writings, what I loved to read & watch that week + other useful insights & analysis exclusively for my subscribers.