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Even after Wednesday’s stock market rout, more analysts are referring to current stock index levels as a “bubble.” I’m one of them, although I make the point that bubbles can last a long time and don’t pop just because valuations are stretched.
It’s helpful to remember that Alan Greenspan called the stock market a bubble in 1996 (that was his “irrational exuberance” speech), but the bubble did not burst until 2000. This bubble won’t go on for four years, but it could go on for months before there’s a significant correction.
But here’s a twist. It’s not only analysts who are calling this a bubble. The Federal Reserve has the same concern. The Fed’s focus is on market volatility as measured by the VIX, which is an options contract on the S&P 500.
The problem with volatility is there hasn’t been any outside of this week’s action. Markets have been complacent and did not expect any sudden moves to the downside. It’s when markets are most complacent that sudden drops are most likely.
August 2015 and January 2016 are good examples. Once stocks stabilize and complacency returns, another drop might not be far behind.
In recent decades, mainstream economists insisted that markets are highly efficient, and do a near perfect job of digesting available information and correctly pricing assets today to take account of future events based on that information.
In fact, nothing could be further from the truth.
Markets do offer valuable information to analysts, but they are far from efficient. Markets can be rational or irrational. Markets can be volatile, irrationally exuberant, or in a complete state of panic depending upon the emotions of investors, herd behavior, and the specific array of preferences when a new shock emerges.
Market commentators had been marveling for months about the lack of volatility in stocks and how the market only seems to go up (or at worst sideways) since the election of Donald Trump on Nov. 8, 2016. Wednesday’s market action put an end to all that for now.
Stocks plunged almost 2%, the most in one day since last September. Volatility spiked, while gold and bonds rallied on a flight to quality. The dollar sank and the euro continued its slow, steady climb above $1.10.
All of this action — basically a month’s worth of market movement crammed into one day — is attributable to the sudden perception in markets that the Trump agenda, and therefore the “Trump relation trade,” is in serious jeopardy.
This is due to revelations involving Russian influence, James Comey’s memos and passing classified information to Russia by Trump. Suddenly, talk of “impeachment” and “President Pence” is in the air.
My job is to stick to markets and not get involved in partisan bickering and D.C. talking points. But when the Washington noise gets loud enough, I have to assess the impact that may have on markets. I’ve been warning about these political dangers for a while, and on Wednesday the market as a …read more
Source:: Daily Reckoning feed
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