With Brexit looming as a possibility, poor economic numbers holding back planned interest rate hikes by the Fed, and Trump leading the GOP into uncharted populist waters, you’d think the financial markets would be in turmoil. But it’s relatively quiet (except for hedges against UK stocks).
What gives? Are the markets efficiently telling us not to worry, or are the markets incapable of responding to these threats?
Neil Irwin at the NY Times tries to unthread this:
[…] traders are efficient at pricing in pieces of news that affect asset prices in predictable ways over the short and medium term. They’re a lot worse at predicting which major threats to the global economy will spiral out of control and which will turn out to hardly matter.
Consider two examples from recent years.
In the summer and fall of 2011, investors were panicked that the eurozone would unravel because of the fiscal crisis that started in Greece. Global stock markets, commodities and risky forms of debt plummeted; volatility skyrocketed.
But things turned out to be more or less fine. More aggressive action by the European Central Bank and European political leaders starting late that year helped calm everyone. And while the European economy is not in great shape, the Continent experienced no epic financial crisis. If you had the nerve to buy eurozone stocks in September 2011, you have enjoyed a 51 percent return on your money.
Other times, instead of being too fearful of cataclysmic events, financial markets are too complacent. What we now call the global financial crisis got its start in mid-2007, as losses on mortgage-related securities mounted and global money markets froze up.
But after some initial efforts by the Federal Reserve and other government officials to contain the damage, financial markets rallied 11 percent from mid-August through mid-October, pushing the stock market to new highs and suggesting all was well. Of course, as it turned out, a severe recession and catastrophic financial crisis were just around the corner. People who bought into any risky assets, whether stocks or mortgage-backed securities, at the October highs lost their shirts.
Some smart people, like strategists at Goldman Sachs, are advancing the possibility that markets could be in a similarly precarious state right now. It may even be that the normal mechanisms through which those fears would translate into lower stock prices and higher volatility indexes are broken right now; many “macro” hedge funds that bet on big seismic changes in the global economy have been losing money for the last few years, and some have closed.
Even if that’s so, the next few months will be a great test of just how much markets really know about the future. And given the precarious headlines of the last few months, anyone who wants to make sure they don’t lose their shirts again should hope that they’ve got it right.
So, is this the market of September 2011 or the market of October 2007? Are these threats to financial stability more like the mortgage overhang that cause the Great Recession, or are we headed for another blip, like the Greek crisis turned out to be?
Whatever comes to pass, remember that the markets tell us nothing. They could be concealing a black hole that will eat the world or a period of continued expansion.
Welcome to the postnormal: the new normal is that there is no normal.
from Stowe Boyd http://www.stoweboyd.com/post/146009937747
