Total Posts:3|Showing Posts:1-3
Jump to topic:

Charlatans, Cranks, and the Stock Market

ResponsiblyIrresponsible
Posts: 12,398
Add as Friend
Challenge to a Debate
Send a Message
8/27/2015 11:33:52 PM
Posted: 1 year ago
The "charlatans and cranks" line, I should clarify, was taken from Greg Mankiw to refer to voracious supply-siders, so whimsical in their thinking (and Greg is a supply-sider, it bears mentioning) that they were convinced that tax cuts would pay for themselves. The same logic applies now to morons (read: Peter Schiff and Donald Trump, though there are plenty of hedge-fund jackarses weighing in, as well).

On Monday, the stock market opened minus 1000 points. Traders were quick to brand this a "correction": "The era of zero rates is over!", they proclaimed, and stocks were merely reflecting this reality that the Fed had long been signaling that its next tightening cycle might begin in September of this year.

Bolder charlatans, like Peter Schiff, think rates are stuck at zero forever! The same guy who has been wrong about literally *everything* since the financial crisis-- who predicted stocks would tank following the end of QE3, for instance, that we would be in a era of hyperinflation, that the Chinese would dump our bonds, that the dollar would tank, etc.--and has made a name for himself as a professional doomsayer who *thinks* he has credibility in predicting the implications for a 2015 liftoff; worse yet, he thinks he can make outlandish prognostications about "QE4." Unfortunately, some more credible figures, not least among them former Treasury Secretary (and runner-up for Fed Chair), Larry Summers, have afforded him a false sense of credibility.

Here's a dirty little secret: financial markets are extremely fickle. They correct, and overcorrect, and overanticipate, and act emotionally, and then retrench, etc. In no plausible way, shape or form does the stock market invariably move with or reflect the underlying fundamentals of the U.S. economy. In fact, good macro data as late has tended to bear negatively on stocks. Why? Because good data means that a rate hike is nearing, which prompts a sell-off in stocks. And then a Fed official says something that caters to the feeble emotions of market participants, like, "September is less compelling," as we heard yesterday from the indispensable Bill Dudley, and they regain their losses.

Stock markets--as a proxy for people's wealth--move up, down, sideways, and upside down on any word by Fed officials which might signal something, anything, about the impending tightening cycle. Fed officials, to their credit, are far more deliberate when it comes to policy deliberations, but obviously it places them in a precarious situation where they need to--speaking for themselves, rather than the Fed as a collective unit--communicate in such a way so as to provide "just enough clarity" to markets. If they don't provide enough clarity, we get the Taper Tantrum.

Market participants are uniquely incompetent at following economic data and gauging the implications for rates (which, to be fair, is understandable given the uncharted waters of the ZLB and the degree of discretion policymakers retain in setting rates). Therefore, if the Fed were to say absolutely *nothing* about rates, markets would make unfounded assumptions. Even if the Fed were to, as they did in mid-to-late 2013, say something so benign as "We're considering, consistent with incoming economic data, beginning to reduce the rate at which we buy bonds"--note that this says *nothing* about the outlook for short rates, about liftoff, or about ending the bond-buying program--markets would throw a complete sh1tfit in a "the sky is falling" sort of way. Never mind that the impact on term premia from the Fed's current--and, at the time, expanding-- portfolio of assets and the expected rate path will keep interest rates virtually unchanged; you need to break this down for financial markets as though they were children. "Efficient markets" my ars.

Then there's the "overcommunicating" piece. In reality, this is less of a problem, or at least at the moment it is. The problem with economics, and particularly with economic data, is that it's esoteric. The average trader won't understand it unless some dipsh1t, like Rick Santelli, were to spell it out for them in an exhausting degree of detail. To that end, the decision on rates is *far* more complex than "Good data, liftoff is coming; bad data, we're holding off." It's a question of the underlying risk calculus: how the forecast will shape out with or without a rate hike, how developments around the world (namely, China, Greece, and EME's) will shape out, the extent to which EME's can withstand a tightening cycle, the ways in which tightening U.S. policy might lead to tighter financial conditions and unintended consequences here and abroad, how to communicate policy in such a manner so as to ameliorate those harms, and more.

This isn't as simple, notwithstanding what John Taylor will have you believe, as plugging numbers into a computer program and receiving an output with the optimal effective funds rate. It's extremely complex, and rate decisions are necessarily uncertain. The Fed can't tell you when and to what extent they're going to move, because even they don't know exactly. There's a divergence of opinion on the FOMC, as there should be, which is why I cannot tell you how unbelievably stupid traders who attempt to make "bets" on the expected liftoff date--via OIS Swaps, fed funds futures, eurodollar futures, and more--are, but nevertheless it's always interesting to pour through that data, if only to make myself feel better that the assymetric gene distribution wasn't to my detriment.

Anyway, where was I? Oh, yes, the stock market. A few points:

(1) The market move on Monday had little, if anything, to do with the expectation of a rate hike in September. Fed fund futures were long betting *against* a September rate hike. The proximal causes were (a) a slowdown in China, (b) falling global commodity prices, namely oil, which bears negatively on earnings, and (c) uncertainty about the outlook for policy *on a global scale.*

(2) The market move was self-reinforcing. Markets will be markets. The expectation of a sell-off begot an even larger sell-off, and thus set off a "correction" for the "correction."

(3) I always get frustrated when I hear "correction," especially when it's in reference to policy moves. It's usually used by high-brow, high-frequency traders and hedge fund managers who assert that "artificially high" equity valuations induced by "artificially low" rates will spawn a "correction." Don't listen to these people: they haven't the slightest clue of what they think they're talking about.

(4) There is no bubble in equities. I cannot stress that enough. If the last few days of stocks regaining their prior losses isn't enough for you to see that, I cannot help you.

(5) QE4 is *not* in the works, nor will it be. If you think otherwise, you either haven't been paying attention or haven't the slightest understanding of how Fed policy balances risks to the outlooks with its own credibility, the latter of which is necessary for policy to have the maximal *real* effects.

(6) Don't focus on stocks. The "wealth effect" is small, protracted, and unimportant, especially because, much like China (and China is a whole other story, with the stock market and the real economy regularly doing different things), equity ownership is an activity of a minority of households. Focus, instead, on the underlying reason for those movements. Is it because markets are worried about liftoff? Doubtful: fed funds futures shifted backward and the 10-year Treasury dipped below 2 percent, signaling the opposite. Is it because of earnings concerns due to dipping commodity prices? Yes, as is typical. Is it because of global growth fears? Absolutely.

Now, the million-dollar question which ties the stock market to policy: Are there material *real* economic effects? The answer, in this case, is an unequivocal yes, but the rationale for holding off is not "market turmoil." It's what t
~ResponsiblyIrresponsible

DDO's Economics Messiah
ResponsiblyIrresponsible
Posts: 12,398
Add as Friend
Challenge to a Debate
Send a Message
8/28/2015 12:11:53 AM
Posted: 1 year ago
As an additional note:

A protracted period of zero rates is *not* the new normal, though rates--in real terms--will probably be far lower than they've been historically. Via two different models (Williams and Laubach (2001) and Paul Samuelson's consumption-loan model), the first of which uses trend growth and the latter population growth, the Wicksellian equilibrium real rate is something like 80 basis points. That's a 120 basis point reduction, so the "normal" nominal funds rate will be something like 2.8 percent. There are several implications of that, which I can discuss at a later date, but there is absolutely *no* validity to Peter Schiff's proclamation that we're perpetually stuck at zero or, worse, that the recovery is a "sugar high."
~ResponsiblyIrresponsible

DDO's Economics Messiah