When frameworks collide

Surface level readings are encouraging – strong market performance, robust economic activity, record earnings growth. But we feel the rumbling below our feet and wonder what seismic changes in technology and geopolitics portend for the economy and markets.

Everyone's heard of confirmation bias. Literary theorist Paul Fry takes things a step further; he argues that everything we perceive is preselected based on our background, training, and analytical habits. Bias implies distortion, spinning data we've already seen. Fry describes an earlier operation, in which our minds build "rules of relevance" that render some information functionally invisible before we ever get the chance to interpret it.

The AI investment boom illustrates the problem. An engineer at an AI lab views the explosive growth in compute capex as a rational response to a binding technical constraint, while a statistician sees an accelerating series with no precedent in the sample, leading to a distribution of outcomes that widens by the day. Neither is wrong. They were simply trained to notice different things. Today’s markets mostly reflect the engineers’ optimism. At some point in the future, don’t be surprised if the statistician’s caution comes to dominate market perspectives.

For years, investors have clung to the expectation that interest rates would return to 2019 levels even as the factors that pinned rates so low in the prior decade largely vanished. It was only when large AI-related bond issuance caught investors’ attention that their analytical framework caught up. Now everyone sees how shifts in the demand for capital can shape borrowing costs.

When viewed exclusively from the perspective of goods trade deficits, globalization seemed like a lousy deal for the United States. But the explosion of cross-border trade generated enormous demand for dollar-denominated safe assets, pushing down the cost of financing US deficits and home mortgages. Now that trade volumes have stagnated and reversed, so too has the United States borrowing subsidy. Had globalization’s benefits not been occluded from public perceptions, it’s not obvious households would have signed up for this trade.

Everyone has heard of the “peace dividend” but it’s not easy to find in the past 20 years of European growth statistics. Yet, one cannot help but notice a correlation between the decline in the continent’s domestic defense-industrial base and its waning global technological relevance. And this stands in sharp contrast to the experience of the United States, China, and Israel, all of whom have experienced massive commercial spillovers from their tech-oriented defense investment. Increased domestic investment in defense systems may reveal the peace dividend to be nothing but a perspectival mirage.

In Rules of Relevance, our newest whitepaper, we explore how “learned blindness” can become a major source of market risk in periods of rapid technological and geopolitical change. It may not be changes in the data that trigger asset price adjustments, but a change in the lens through which investors interpret the data.

As Mark Twain said: “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.“