The latest ‘New Normal’ backlash(es) | FT Alphaville

The latest ‘New Normal’ backlash(es)

The New New Normal apparently means to bash the old New Normal.

They say that three makes a trend in journalism. Never mind that we don’t know who “they” are, or that it’s quite a silly notion. We’ve got four examples of something interesting, and we plan to share them now regardless of whether they’re indicative of anything bigger.

First up is Catherine Rampbell at Economix, who interviews and cites a new paper by economist David Laibson:

In the paper, and in person, Professor Laibson argued that the economy will always revert back to its long-term growth trend, but people still tend to freak out about sudden shocks to the system in the short-term and assume they present a permanent diversion from that long-run trend. That is, they interpret the terrible economic conditions resulting from a financial crisis as the “new normal,” and likewise the buoyant economic conditions associated with a bubble.

This obsession with a “new normal” lends some momentum for the current catastrophe or craze, but nonetheless subsides as things eventually return to their long-run trend.

Rampbell adds a smart quibble to Laibson’s argument — the ‘New Normal’ wasn’t necessarily intended to be the ‘New and Forever Normal’. It was just a way to describe a shift in the economy that will be sustained for an abnormally long period of time, but not forever.

Next is James Montier’s latest paper, “In Defense of the Old Always” (via ZH):

The concept of the “new normal” abounds in markets these days. It seems I can’t open the Financial Times without at least one headline proclaiming the importance of the new normal. But what does it mean for the way we invest?

Part of the difficulty in answering that question is the plethora of meanings that have become associated with the term “new normal.” For some, it is an environment of subdued growth in the developed markets (the result of ongoing deleveraging – similar in essence to the “seven lean years” that Jeremy Grantham, among others, has previously described). For others, it encapsulates a prolonged period of high volatility (in either economies or asset markets).

According to PIMCO, the coiners of the term, the new normal is also explained as an environment wherein “the snapshot for ‘consensus expectations’ has shifted: from traditional bell-shaped curves – with a high likelihood mean and thin tails (indicating most economists have similar expectations) – to a much flatter distribution of outcomes with fatter tails (where opinion is divided and expectations vary considerably).” That is to say, the distribution of forecasts has become more uniform.

For some economic variables, this is certainly an accurate description. … However, the flatter distribution with fatter tails version of the new normal shouldn’t be taken as a universal truth.

And this bit, a little further on in Montier’s paper, is amusing:

This certainly isn’t the first premature obituary written for mean reversion. During pretty much every “new era,” someone proclaims that the old rules simply don’t apply anymore … who could forget Irving Fisher’s statement that stocks had reached a “permanently high plateau” in 1929?

Mean reversion is in some august company in being well enough to read its own obituary. Men as varied as Samuel Taylor Coleridge, Ernest Hemingway, Steve Jobs, Rudyard Kipling, and Mark Twain were all recipients of the news of their own demise. Personally, I think Kipling’s response was among the best. Upon learning of his departure from the mortal coil while reading a magazine, he wrote to its editors, “I’ve just read that I am dead. Don’t forget to delete me from your list of subscribers.”

Third on the list is Morgan Stanley, with a blog post early Wednesday:

New normal: RIP? We don’t want to short-change the growth debate; it remains central, as the tepid employment report underscores.  Non-farm payrolls rose just 103,000 in December; inclement weather likely depressed the job tally somewhat.  It’s far from a boom or even a truly vigorous recovery.  Nonetheless, average monthly private payroll growth in 4Q10 was the strongest in nearly four years.  Thus, despite well-worn and obvious, lingering headwinds, we think that the debate about growth is largely over.  And several factors at the least assure moderate growth and raise the odds of a more bullish outcome this year and next: the combination of generally better-than-expected incoming data, faster-than-expected deleveraging, the one-two punch from new fiscal stimulus and a Fed committed to achieve its dual mandate, and a dramatic reduction in political uncertainty.  Consequently, we continue to expect 4% real growth over the four quarters of 2011.

Finally, this is from a paper by Andrew Redleaf of Whitebox Advisor back in December that was titled “The new normal, the old normal, or just, you know, normal?” (Leaked to us: we don’t have a link):

“Risk on/risk off” is an expression I’ve never heard before sometime in 2009. But for almost two years now it’s been the rage, the hip way to describe almost any trade. Trades were all either “risk off,” which meant buying Treasuries, basically, or “risk on,” which meant doing almost anything else but especially buying commodities. As that dichotomy suggests, one way to look at the risk-on/risk-off choice is that it is another way of saying inflation/deflation. But that does not catch the real spirit of the thing. After all, how often do we have a deflation that matters? Only during an absolute financial catastrophe. What risk/risk off really translates to is: Armageddon/not Armageddon; end of the world/not end of the world.

This is not normal and never was sustainable. In most times and most environments the possibility of financial Armageddon is not on the radar screen. Nicholas Taleb of The Black Swan fame would argue this complacency is a profound error, that the possibility of a wipeout should be taken more seriously at all times. It’s his fundamental idea. Yet even Taleb makes only modest claims for the utility of constantly expecting disaster. His only strong practical conclusion is that neglecting the possibility of total disaster leads to systematic mispricing of out-of-the-money options, not of assets in general. …

Risk on/risk off is out of line with what even the investors who are still trading that way actually believe. A year ago risk on/risk off and inflation/deflation were the right dichotomies. Today the consensus is that we are moving toward “the new normal” with growth moving in a range between 1 and 3%. (To those of us who cut our teeth in the ’70s this is actually the “old normal” otherwise known as “normal.”) Trendless mediocrity: perfect for stock pickers.

Some of these criticisms, especially those of Redleaf, are as much about the language of the phrase as the underlying substance — the use of the word “New” to describe something that isn’t new at all.

But as to whether the critics write about the more fundamental points of the New Normal (i.e. whether developed nations are entering a long or permanent period of below-historical-trend growth, and the rest of it) — well, just a day removed from a long discourse on the perils of forecasting, we’re not going there. Just thought it was something interesting to pass along.

Related links:
Economic forecasting delusions – FT Alphaville
An eye-catching quote – FT Alphaville
Bernanke’s genie released – FT Alphaville
Something exceptional happening in volatility – FT Alphaville