Stock Market: Roller Coaster With More of A Brain Than It Looks

Robert J. Shiller, a 2013 Nobel laureate in economics, is Professor of Economics at Yale University and the co-creator of the Case-Shiller Index of US house prices. He is the author of Irrational ExuberancePhishing for Phools: The Economics of Manipulation and Deception (with George Akerlof), and Narrative Economics: How Stories Go Viral and Drive Major Economic Events.

Professor Shiller is baffled by recent stock markets antics:

NEW HAVEN – The performance of stock markets, especially in the United States, during the coronavirus pandemic seems to defy logic. With cratering demand dragging down investment and employment, what could possibly be keeping share prices afloat?

The more economic fundamentals and market outcomes diverge, the deeper the mystery becomes, until one considers possible explanations based on crowd psychology, the virality of ideas, and the dynamics of narrative epidemics. After all, stock-market movements are driven largely by investors’ assessments of other investors’ evolving reaction to the news, rather than the news itself.

That is because most people have no way to evaluate the significance of economic or scientific news. Especially when mistrust of news media is high, they tend to rely on how people they know respond to news. This process of evaluation takes time, which is why stock markets do not respond to news suddenly and completely, as conventional theory would suggest. The news starts a new trend in markets, but it is sufficiently ambiguous that most smart money has difficulty profiting from it.

 

NEW YORK, NY – JUNE 18: Traders and financial professionals work on the floor of the New York Stock Exchange (NYSE) at the closing bell, June 18, 2019 in New York City. U.S. markets surged on Tuesday after President Donald Trump announced that he plans to meet with Chinese President Xi Jinping to discuss a trade deal at next week’s G-20 summit in Japan. Guy on the right was probably short…(Photo by Drew Angerer/Getty Images)

Prof Shiller:

There are three separate phases of the puzzle in the US: the 3% rise in the S&P 500 from the beginning of the coronavirus crisis, on January 30, to February 19; the 34% drop from that date until March 23; and the 42% upswing from March 23 to the present. Each of these phases reveals a puzzling association with the news, as the lagged market reaction is filtered through investor reactions and stories.

The first phase started when the World Health Organization declared the new coronavirus “a public health emergency of international concern” on January 30. Over the next 20 days, the S&P 500 rose by 3%, hitting an all-time record high on February 19. Why would investors give shares their highest valuation ever right after the announcement of a possible global tragedy? Interest rates did not fall over this period. Why didn’t the stock market “predict” the coming recession by declining before the downturn started?

… The second phase began when the S&P 500 plummeted 34% from February 19 to March 23, a drop akin to the 1929 stock market crash. Yet, as of February 19, there had been only a handful of reported COVID-19 deaths outside of China. What changed investors’ thinking over that interval was not just one narrative, but a constellation of related narratives.

What changed is that the Turin-Milan region, the economic powerhouse of Italy, had to lock down, following the extremely severe lockdown in China. It was obvious that the world was going to lockdown. Indeed, Shiller admits the crisis was terrible:

…”some people in locked-down China reportedly were reduced to searching for minnows and ragworms to eat. In Italy, there were stories of medical workers in overwhelmed hospitals being forced to choose which patients would receive treatment. Narratives about the Great Depression of the 1930s flourished.” Some people were also caged in their houses in Wuhan, with bars added to their windows…

“The beginning of the third phase, when the S&P 500 market began its 40% rise, was marked by some genuine news about both fiscal and monetary policy. On March 23, after interest rates had already been cut to virtually zero, the US Federal Reserve announced an aggressive program to establish innovative credit facilities. Four days later, Trump signed the $2 trillion Coronavirus Aid, Relief, and Economic Security (CARES) Act, promising aggressive fiscal stimulus.

Both of these measures, and similar actions in other countries, were described as resembling the actions taken to counter the 2008-09 Great Recession, which was followed by a gradual but ultimately huge increase in stock prices.”

And professor Shiller to conclude with his trademark:

“In all three phases of the COVID-19 stock market, the effects of genuine news are apparent. But price movements are not necessarily a prompt, logical response to it. In fact, they rarely are.”

Here is my comment, I see cleverness and logic, where Shiller is lost and baffled (but he got his irrational exuberance Nobel, I didn’t!):

This roller coaster seems all very logical to me. In the first phase, the epidemic seemed a blip. The important news was that the Trump impeachment was a hoax, which had failed. Trump and his light taxation, and capital repatriation, good for earnings, and the future US economy, were marching to re-election. 

Then it turned out that the world was confronted to a nasty, unstoppable pandemic, the world economy  was going to crater, thus so would earnings. Earnings doomed to crash, stock markets crashed. 

Then, in phase three, a financial miracle and cosmical bonanza was discerned, by the wealthiest, for the wealthiest. The central banks, and even Germany, decided to make and distribute enough free money to get the biggest companies to keep going, even if their standard earnings had mostly disappeared (say airlines). Call that synthetic earnings, but earnings nevertheless. 

Also the way out of the pandemic is to innovate (so the tech heavy NASDAQ took off). 178 vaccines are under development. Some biotech will, and have, scored (especially as quinine + macrolide antibiotic is neglected).

So now what? More of the same. There are tweaks, though, as some trends are increasingly blatant: small companies are getting less help than the big ones. Some countries (Taiwan, Korea, Japan, dreaded China) are mostly industrially intact because they mastered the pandemic. Many other emerging countries will get submerged, having lost their money making exports (and no central bank will save them). Some sectors (fossil fuels) seem doomed (as investment goes down, fields perish). 

All of this new reality is reflected in stock valuation trends, worldwide. The US presidential election guarantees that central bank money will keep on flowing. TINA: There Is No Alternative. Just don’t invest in what is dying. 

By the same token, if Biden gets elected, standard health stocks and green stocks should go up… And notice the market is smiling…

***

We are in a logical world. If some of us don’t see the logic, it does not mean its’ not there… And yes, free money goes to the wealthiest. They are those the wealthiest (central banks, and large “private” banks) lend to. Not easy to change, and there are easier ways to improve the lives of We The People…

Patrice Ayme

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One Response to “Stock Market: Roller Coaster With More of A Brain Than It Looks”

  1. Gmax Says:

    Thanks for the free financial advice! Why do you say Shiller plays dumb?

    Like

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