Market Blindness or Rational Behaviour

May 2026 | Andrew Hunt

Real events frequently change the ability of economies to produce things, sometimes for the better (for example finding new mineral deposits or experiencing an influx of productive workers), and sometimes for the worse. Wars and energy quantity shocks definitely fit into the latter category.

As a result of what now look to be long-running issues with the Straits of Hormuz – even if the Straits re-open today will tanker owners and crews rush back in, or merely see this as an opportunity to get trapped ships out, it seems that the global supply of hydrocarbon inputs has been compromised. This of course covers not just the availability of fuels, but plastics, chemicals and even electronic components. The conflict in the Gulf in all probability implies that either the World will not be able to produce as much in 2026 as it did in 2025, or that supply growth will at best be minimal.

Since we cannot buy what is not available, the compromised level of supply needs to be rationed between would-be users. In a command economy, this rationing is simply done by official decree at the behest of national planners. In “free markets”, it is the price mechanism that allocates the supply by increasing the nominal price of the goods and services that have been affected relative to people’s nominal spending power (i.e. their incomes & ability to borrow). For many people, if not most, the supply shock reduces real incomes so that they consume fewer “things”, and thereby equilibrium between supply & demand is restored.

However, in today’s world that is short on the analysis of reality, the notion of falling real incomes and the recession that is implied in this process is anathema to many politicians. Policies announced on X and shaped by political focus groups within governments tend always to be short term in nature and geared to maximizing their political impact. There is therefore a tendency for governments to attempt to act in a way to ease any hardship faced by the electorate, even if there is nothing that they can actually do to resolve the underlying problem. Ms Rayner’s recent comments in the UK are a simple illustration of the political imperative.

“Angela Rayner has issued a warning over the domestic fallout of the Iran war as she urged the Government to take "bold action" to help with people's water, housing and energy costs.”

By direct action, we assume that she is implying fiscal subsidies and perhaps even direct price controls. Of course, short of “forcing the Straits” with gunboats (that the RN doesn’t have…), none of what Ms Rayner is advocating will actually solve the underlying energy issue in the near term. She is instead advocating attacking the symptoms / mechanism of the adjustment process, by either lifting people’s nominal incomes so that they could in theory afford to buy something that isn’t in fact available for sale, or limiting the price of things so that the scarce resource has to be allocated by some other means (command economy rationing, corruption, or simple favouritism we assume).

Lifting people’s nominal incomes via presumably monetized fiscal measures does give people more money that they could use to finance a bidding war for scarce resources, thereby creating more price inflation in the things that are now in short supply, and the same eventual decline in real incomes. This all seems rather futile, but governments – particularly the USA - are it seems attempting to do this very thing by expanding budget deficits and in the US’s case the amount of money in the system.

As any student of economics knows, if the price of something rises there will be a substitution effect – higher oil prices may increase the demand for EVs etc. They will also lower the demand for driving and going out in general.

Therefore, if governments contrive to give people more nominal spending power, they may try to buy more of other things rather than the same amount of fuel etc., then this is of course inflationary for these other things - and these “other things” may include financial assets. This is one reason why financial markets seem so far to have been able to seemingly ignore what is occurring in the Gulf.

The Make-Up of Markets

Then there is the internal dynamics of markets. For an asset management or brokerage firm, it is volume of sales that pays the bills – higher asset prices are nice to have in that they raise the a.u.m, and the deal sizes, thereby raising fee income and commissions to an extent, but it is the volume of sales and transactions that matter most to the firms’ bottom lines and the renumeration of the staff. This has for a long time created a bias within market commentators and others to be perpetually optimistic and, to be honest, this is an approach that has worked exceedingly well in during a time in which policymakers seem to have become serial inflators of market bubbles and providers of moral-hazard-breeding implied insurance of market prices.

Portfolio managers also face a career risk if they underperform in a rising market and, although they might face the ire of clients if they fall in line with a market decline, they will rarely lose their jobs for such an apparent oversight.

For analysts, it is generally thought better to be just one side or the other of the consensus with one’s opinions – taking seemingly extreme positions seems like a career risk. This author remembers being “fired” for expressing a negative view of the RMB against the trend in consensus thinking during late 1993, and then thankfully being hurriedly re-hired when the currency lost a third of its value and our bank lost a great deal of money. Big calls carry risks and you will not always get them right.

Moreover, the prevailing forecasting tools often rely on mean-reverting models based on post year 2000 data, not least of all because it is now hard to get data before then. This makes analysing new events that any analyst might not have seen before difficult from a practical perspective. To even remember the 1973 oil shock, one now needs to be of retirement age. Throw in some uncertainty over the rather unique policymaking process at present and analysis becomes almost prohibitively difficult.

As a result, it just becomes easier to follow the trend and talk about themes that are conceptual and nebulous – things that are more like a “faith” than something analytical.

It does seem that much of the World likes to place “faith in things & people” at the centre of decisions, despite all of the data processing power that we now possess. How many politicians have been elected on the basis of people’s belief in them, even if it was unwarranted? Hence the rise – and now fall - of populist leaders. Talking about running a country, and actually doing so, are plainly very different things.

Today, markets have a longstanding faith based on decades of experience that policymakers will always seek to manage markets, that outcomes are never as bad as the Cassandras suggest, that AI will change the World despite its energy consumption, that gold will return as a store of value, that cryptocurrencies are the answer etc. Ironically, we are in a world based on faith in celebrity-type politicians and influencers, the justification for which can be expressed in only a small number of characters on “X”. In this World, any deviation by markets from a recent trend is simply seen as a temporary aberration that will soon be corrected by some omnipotent action.

In short, absent something so big that they cannot ignore, markets have a seemingly unshakeable confidence in their future, even if many people outside the markets’ parochial bubble in the real economy apparently have little faith in their own personal outlooks or in the very same policymakers. This is the glaring dichotomy between Main Street and Wall Street.

Textbooks tell us that asset market prices are based on discounted cash flows or some other fundamental tool, but in reality the price of anything – including that of an equity or credit instrument - is determined by current demand versus supply. In financial markets, supply changes relatively slowly but demand is essentially the product of money times confidence. Therefore, if markets have confidence (rightly or wrongly), and then more money turns up either because of the “substitution effect” described earlier, and / or because governments are adding more money, then asset prices can rise and seemingly re-affirm the markets’ faith.

This is where we have been over the last month and we may have further to go down this road. The divergence between the financial and real economies may have further to go, particularly as policymakers seek to grow the nominal – financial economy to hide what is going on in the real economy.

There will come a time, however, when policymakers will have to recognize that all that they have achieved is the same level of aggregate supply but with higher prices – the very definition of stagflation. This moment of clarity usually only arrives when the middle income marginal voter starts to protest (hence Mrs Thatcher was elected by the squeezed middle classes…) and at that point central banks are called upon to remove money from the system and also focus not on maintaining financial asset prices but on protecting the value of money. In this regard. Mr Warsh’s ascendency, and that of the “Druckenmiller alumni “ is interesting.

The perception of no longer being the “favoured child” for policymakers will likely dent market confidence; at that point money times confidence will fall and so too will markets. Usually, this process starts slowly in the fixed income markets but then the equity markets “overtake” the bond markets for a period as they come to realize that the World has changed. The latter part of this year may yet be interesting.