Saturday, October 18, 2014

Economy: Are The Markets Irrational?

(Drivebycuriosity) - Last week the fluctuations on the international financial markets continued.  According to Bloomberg we experienced "one of the most volatile five days for stocks since the financial crisis ended" (bloomberg). The decline of the US stock market started around September 19th. Then some traders began to dump anything which seemed risky, causing others to sell too, which lead to a snowball effect of more and more selling. The result were downward spiraling stock prices and culminated in steep declines last Wednesday morning. The S&P 500, the gauge for the US stock market, dropped in this period almost 10% from its peak in September and interest rates for short term US government bonds, the benchmark for the bond market, fell below 2%.

If we believe the media the sell off was caused by fears that the global economy will fall into a deflation, that the Fed will lift their interest rates too fast (which is contrary to the deflation fears) and the Ebola hysteria.

This fears are at odds with the fundamental data: Last weekend China reported rising exports (plus 15.3% in September from the year-ago period), a signal for a solid global economy, in the US the weekly jobless claims dropped onto a 14 years low while industrial production rose 1%. Oil and other commodities got significantly cheaper, which is a boost for the global economy because of the saved costs (Citibank sees savings of 1 trillion dollar for the world economy), and interest rates are on record lows. "You’d be hard-pressed to find a 5-year period in US history where the economic trajectory was more stable", reports the blog csen (csen). Panic attacks, as seen last Wednesday, in such a solid economic environment don´t make sense. Are the markets irrational?

The hectic swings we saw in the recent days are caused by herding behavior. Hedge funds and other speculators typically buy and sell the same stocks, at the same time, and track each other's investment strategies. In the recent days they were again guided by fear and ignorance, as they were in August 2011. Since its start in spring 2009 this economic upswing - and the accompanying stock market rally - is dismissed by the majority. There seems to be a permanent climate of fright and ignorance of any positive news. For instance the overdue popping of the oil price bubble (driveby) is misinterpreted as sign of deflation.

I think this irrational fear - being obsessed with negative news while blinding out positive facts - is an occasion for investors with good nerves and long time horizon.

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