1. Scott Sumner:
Note that the instant reaction of stocks is a more reliable indicator of monetary policy that long term bond yields. Long term rates rose on the announcement of QE3, and rose again on taper talk. Why is the long term bond market so schizophrenic? I have no idea.
2. A press release about a new behavioral economics study:
Dr Benedetto De Martino, a researcher at Royal Holloway University of London who led the study while at the California Institute of Technology, said: “We find that in a bubble situation, people start to see the market as a strategic opponent and shift the brain processes they’re using to make financial decisions. They start trying to imagine how the other traders will behave and this leads them to modify their judgment of how valuable the asset is. They become less driven by explicit information, like actual prices, and more focused on how they imagine the market will change.
“These brain processes have evolved to help us get along better in social situations and are usually advantageous. But we’ve shown that when we use them within a complex modern system, like financial markets, they can result in unproductive behaviours that drive a cycle of boom and bust.”
The team found that when participants noticed disparity between how much they perceived an asset to be worth and the rate of transactions for that asset, they began making poor business decisions and bubbles started to form in the market.
Professor Peter Bossaerts from the University of Utah, a co-author of the study, explains: “It’s group illusion. When participants see inconsistency in the rate of transactions, they think that there are people who know better operating in the marketplace and they make a game out of it. In reality, however, there is nothing to be gained because nobody knows better.”
Colin Camerer, Robert Kirby Professor of Behavioral Economics at the California Institute of Technology, said: “There’s a mathematical measure of when the flow of traders’ orders to buy or sell changes from steady to choppy. A choppy flow is a clue that trades are bunching up around new information or pausing to see what happens next. This way of measuring has been sitting on the shelf for years. This is the first study to show that it seems to correspond to what the brain is computing.”
My own view is that the stock market is efficient in the sense that returns are nearly impossible to forecast, but it is not rational. In 1979, stocks may have been undervalued by a factor of two or more. By 2000, they may have been overvalued by that much. Given that I think that the market can be off base by 50 percent, I am reluctant to draw inferences about moves of 2 or 3 percent.
Your closing comments about valuation put you in good company: š
“However, we might deļ¬ne an efļ¬cient market as one in which price is within a factor of 2 of value, i.e., the price is more than half of value and less than twice value. The factor of 2 is arbitrary, of course. Intuitively, though, it seems reasonable to me, in the light of sources of uncertainty about value and the strength of the forces tending to cause price to return to value. By this deļ¬nition,I think almost all markets are efļ¬cient almost all of the time. ‘Almost all’ means at least 90%.” – Fischer Black
I just read the linked Fischer Black paper, seems like a seminal work that anticipates many current trends and modes of thought. For example, he outlined PSST 27 years ago, even using the phrase “entire pattern of tastes and technologies” at one point: š
“if business cycles are caused by unanticipated shifts in the entire pattern of tastes and technologies across sectors, we might call that uncertainty noise. I believe that these shifts are signiļ¬cant for the economy as a whole because they do not cancel in any meaningful sense. The number of sectors in which there is a match between tastes and technology varies a lot over time. When it is high, we have an expansion. When it is low, we have a recession.
One reason the shifts do not cancel is that they are not independent across sectors. When the costs of producing goods and services that require oil are high,they will be high across many related sectors. When demand for vacation homes is high, it will be high for many kinds of related services at the same time. The more we divide sectors into subsectors, the more related the subsectors will be to one another.
It is not clear whether the increasing diversity and specialization that go along with the transition from a simple economy to a complex modern economy will be associated with larger or smaller business cycles. On the one hand, the diversity in a more complex economy means that a single crop failure or demand shock cannot have such a devastating effect; but on the other hand, the specialization in a more complex economy means that when there is a mismatch between tastes and technology, it is costly to move skills and machines between sectors to correct the mismatch.
Money and prices play no role in this explanation. Everything is real. For a small sample of the kind of thing I have in mind, suppose I gear up to produce dolls, while you gear up to produce art books. If it turns out that you want dolls and I want art books, we will have a boom. We will both work hard, and will exchange our outputs and will have high consumption of both dolls and art books. But if it turns out that you want action toys and I want science books, we will have a bust. The relative price of toys and books may be the same as before, but neither of us will work so hard because we will not value highly that which we can exchange our outputs for.
This is just one kind of example. The variations can occur in use of machines as well as in use of people, and the underlying uncertainty can concern what we can make as well as what we want.
Unanticipated shifts in tastes and technology within and across sectors is what we call information in discussing financial markets. In economic markets, it seems more appropriate to call these shifts noise, to contrast them with shifts in the aggregates that conventional macroeconomic models focus on. In other words,the cause of business cycles is not a few large things that can be measured and controlled, but many small things that are difļ¬cult to measure and essentially impossible to control.
Noise or uncertainty has its effects in economic markets because there are costs in shifting physical and human resources within and between sectors. If skills and capital can be shifted without cost after tastes and technology become known, mismatches between what we can do and what we want to do will not occur.
The costs of shifting real resources are clearly large, so it is plausible that these costs might play a role in business cycles. The costs of putting inļ¬ation adjustments in contracts or of publicizing changes in the money stock or the price level seem low, so it is not plausible that these costs play a signiļ¬cant role in business cycles.
Presumably the government does not have better information about the details of future supply and demand conditions within and between sectors than the people working in those sectors. Thus there is little the government can do to help the economy avoid recessions. These unknown future details are noise to the workers and managers involved, and they are noise twice over to government employees, even those who collect statistics on individual industries.”
The rest of the paper has other nuggets that are just great, š very worth reading.
Doug Noland writing in Safehaven.com article make some relative comments, With Credit and asset markets feeding upon each another, I’ll paraphrase George Soros’ Theory of Reflexivity: Perceptions tend to create their own reality. Credit cycles have been around for a very, very long time. We’re in the midst of a historic one.
Credit fundamentally changed in the nineties, with the proliferation of market-based Credit (securitizations, the GSEs, derivatives, “repos”, hedge funds and “Wall Street finance”). Unbeknownst at the time – perhaps to this day – marketable securities-based Credit created additional layers of instability compared to traditional (bank loan-centric) Credit.
I comment that Liberalism achieved peak prosperity on a non taper rally. On going monetization of debt, specifically Ben Bernankeās call for no tapering, that is for QEternity, made for a sell of the US Dollar, $USD, which closed the week down 1.2% at 80.56, and propelled Nation Investment, EFA, 2.2%, World Stocks, VT, 1.6%, Global Producers, FXR, 1.4%, US Stocks, VTI, 1.3%, and the S&P 500, SPY, 0.8%, to new all time highs.
With Fed Chairman Ben Bernanke affirming QEternity; itās provision constitutes passing the Rubicon of sound monetary policy as evidenced by the trade lower in World Stocks, VT, on Friday September 20, 2013. Peak Prosperity has come via a policy of investment choice in the moral hazard based fiat money system, which is based on schemes of credit and carry trade investing, all designed for investment gain.
The zenith of liberalism was foretold in the statue of empires, as foretold in Bible prophecy of Daniel 2:25-45, where two iron legs of hegemonic power, would rise to rule the world, these being the British Empire, and the US Dollar Hegemonic Empire, only to experience dissolution into an unstable mixture of ten toes of iron diktat and clay democracy, that is ten zones of regional governance and totalitarian collectivism, this being confirmed by the rise of the Beast Regime of Revelation 13:1-4, to replace liberalismās Banker Regime. Godās idea of economy has been, is now, and will ever be one of empire. The Libertarian dream of freedom, and free things like āfree pricesā for labor, for example, is an illusion on both the liberalism as well as authoritarianism ādesert of the realā.
Under authoritarianism, the schemes of debt servitude schemes, are the order of the day and include such things as regional framework agreements, bank deposits bailins, new taxes, privatizations, capital controls, austerity measures, and statist vitalizations where banks and other corporations are given charter to operate as public private partnerships for regional economic security, regional stability and regional sustainability; all of which enforces austerity.
Sectors rising included Solar Stocks, TAN, 3.8%, Nasdaq Internet, 3.6%, Home Builders, ITB, 3.0%, Small Cap Pure Value, RZV, 2.4%, Casinos and Resorts, 2.2% higher. Global Real Estate, DRW, popped 3.9%, higher.
The Eurozone, EZU, rose 3.1%, to a new rally high, as Italy, EWI, rose 3.8%, Spain, EWP, 3.6%, Germany, EWG, 3.3%, and Ireland, Ireland, EIRL 3.2%, and Finland, EFNL, 3.0%.
Emerging Markets, EEM, rose 2.2%, to a new rally high, as Turkey, TUR, rose, 9.5%, Chile, ECH 4.9%, Argentina, ARGT, 4.7%.
US Stocks, VTI, rose 1.4%, and the S&P 500, SPY, 0.8%, both to new all time highs, with the chart of the S&P 500, $SPX, showing a rise of 1.3% to its new all time high.