Signal & Noise Filter
All Along the Watchtower
“Theres too much confusion, I can’t get no relief….”
Said Bob Dylan but performed better by Jimmy Hendrix, in this writer’s opinion.
The above reflects the disbelieve over a market that has had one of its strongest comeback streaks ever whilst in what is arguably the largest energy crisis, ever.
Make it make sense!
These pages will strive to do just that by focusing on frameworks, not predictions. That said, Destiny is still in play in the targets laid out last week – both in original form and revised.
We start by reminding readers of a framework these pages used to map out the 2025 post-taco trade last summer. After getting a reflexive spring bounce in May and June, the question investors were grappling with at the time was, what is the future impact of the tariffs on the economy? Wen Q3 or Q4 2025 recession?
These pages took the contra on July 19, 2025 and made a firm case for remaining bullish on the U.S. economy, and on risk assets, based on the forward looking probabilities that the market was pricing.
The model that was used was simple: a variant of the Monty Hall Problem. The relevant excerpt is shown below.
Suppose you are on a televised macroeconomic game show. You are given the choice of one of three doors. Two of the doors have a turd for a prize, symbolizing low or negative growth. Behind one of the doors is a Lamborghini sport car, symbolizing a bull market.
You pick door one, not knowing what it is behind it of course.
Meanwhile, the game show host – who has perfect information – opens door three and reveals a turd.
You now have an option to stay with door one (the unknown turd), or switch to door two (the Lambo).
What do you do?
Being the clever thinking person you think you are, you reason that left with two options, your choice is a fair value 50/50-coin toss of chance.
You will either get a turd market or a bull market Lambo.
Recall, you do not know that behind your initial choice of door one, lies a turd.
This is wrong way to think about the problem.
The reveal of the turd behind door three introduced new information: the odds of the Lambo being behind door three fell to zero.
The joint odds of the Lambo being behind door two OR door three were always 66% (1/3 + 1/3).
Eliminating door three as a Lambo door concentrates the probability of the Lambo being behind door two to 66%.
Frederich Hayek, patron saint of free-market libertarians, emphasized that prices act as a form of information within an economy because they aggregate and transmit dispersed knowledge.
Recent price action has informed market participants that the near-term probability of a recession is at or near zero.
That is, door three has been opened and we know that a recession is off the table between now and calendar year end.
Thus, the probability of a 2025 bull market has gone from 1/3 to 2/3.
With improved future probabilities, economic agents (firms and consumers) are better able to re-consider their appetite for real, economic risk to the upside, and act accordingly.
For those with physics envy, think of the above as a slow motion Lévy Flight, which is a random walk characterized by small displacements and occasional very large displacements.
In market speak, this is a repricing of market expectations, from a turd to a Lambo.
/FIN
Markets find themselves in a similar place of price discovery and probability mapping as they did last year. With President Trump looking for an off-ramp, he has revealed new information:
A quick resolution is the new strategic goal.
Other considerations are taking a back seat; the red lines are fictional narratives. GTFO is the new political reality for an unpopular war no one wanted.
The worst case is off the table.
By eliminating the economic turd of a recession due to an extended interruption of supply lines, the market is now probabilistically weighing a continuation of the bull market.
Markets Are Not Ignoring the Shock