Volatility, Thought Flu And Other Stories From The Correction

“The Dow Jones Industrial Average has swung by triple digits in seven of the past 11 trading days, erasing the calm that dominated Wall Street through much of the year…But what felt like stomach-churning action [in stock markets] over the past few weeks actually pales in comparison to what transpired 27 years ago…’This is not a ‘new normal’ but rather a regular, run of the mill, old-fashioned normal stock market.”  The same, however, probably can’t be said about bond markets: “If you are steeped in bond market lore, you will be telling your grandchildren about this move.”

 

Gavyn Davies points to three separate factors driving the volatility: 1. “a reversal of speculative positions, which has had temporary effects on asset prices,” 2. “a contractionary and deflationary demand shock in the euro area,” and 3. “an oil shock that will also be deflationary, but will be expansionary for many economies.”  Meanwhile, Mohamed El-Erian has 4 lessons from last week’s wild market: 1. “It doesn’t take much to severely dislocate markets, both down and up,” 2. Market movements are “jerky” thanks to a. broker-dealers are restricted from keeping “unwanted but fundamentally sound positions on their balance sheets,” (Paul Volcker doesn’t quite agree) and b. “too large a segment of the investment community is in crowded trades” (maybe over-leveraged?), 3. Prices dislocated from fundamentals in certain segments means “the markets become overly sensitive to unanticipated news, such as the Ebola epidemic,” and 4. “the Fed still doesn’t have much appetite for financial volatility, and markets will readily embrace its reassurances that it will try to act to counteract these gyrations.”  “Together, these four lessons suggest that, rather than being a one-off event, last week’s volatility is better seen as an indication of what may lie ahead.”

 

Or maybe you’d prefer what this index says about what may lie ahead?  Either way, Robert Shiller says that “stock markets are driven by popular narratives, which don’t need basis in solid fact.  True or not, such stories may be described as ‘thought viruses.’  When they are pernicious, they are analogous to the Ebola virus: They spread by contagion.”  Read on to hear why Robert Shiller thinks the worst “thought virus” out there is secular stagnation.  Speaking of which, here’s the fundamental argument behind secular stagnation: “treating a country’s growth rate as a permanent characteristic rather than a transient condition is a bad idea.”  “We are trying to reverse the default assumptions often made in forecasting GDP, which is that, in the absence of any reason to think otherwise, the current growth rate persists.”  Granted, Larry Summers (head architect of the secular stagnation crowd) is talking about China here, but this kind of thinking can be applied to really any type of forecast.