New York: You might not have noticed, but financial markets have gone kind of nuts. They don’t seem to be following the old rules that governed stocks and other investments in the past.
Generally, bad news drove stocks down.
Small investors would get nervous whenever confidence-rattling news like a trade conflict popped up. Whether or not you sell stocks when you receive bad tidings, the sense that there’s a relationship between rotten news and market dives gives the comforting feeling that you just might understand economics, at least a little.
But today’s rising stock market seems to defy gravity. Nothing really slows it down for long, at least so far: not trade wars, domestic political deadlock and strife, international tensions or, of course, the increasingly obvious disaster of climate change.
Not an end to business cycles
I’m not claiming that we’ve done away with the business cycle of booms and busts. Supposedly smart people made that claim in the 1990s and in 2000, during the dot-com boom. Technological innovation had helped create a New Economy that would leave the business cycle in the dustbin of economic history, or something like that.
The arguments sounded almost plausible until things went south. By 2001, we were in a recession, and even before that decline, markets faltered. Turns out that all that talk of transcending business cycles was a bad case of irrational exuberance, as economist and Federal Reserve Chairman Alan Greenspan memorably put it.
Failure to read the signs
By the mid-2000s, things were humming along again, and the real estate market was doing very, very well — though some sourpusses warned that things were getting a little, you know, exuberant. Nobody loves a naysayer, though, and a prominent economic commentator named Larry Kudlow criticised what he called “the bubbleheads who expect housing-price crashes in Las Vegas or Naples, Florida, to bring down the consumer, the rest of the economy and the entire stock market.”
Despite rosy proclamations like that, we know what happened next: That bubble, too, burst, and the Great Recession sent the economy into the doldrums for years.
What happened to the economist who so confidently talked about the bubbleheads? Let me Google here for a sec. Kudlow. Whatever happened to that guy anyway?
Oh. He now advises the president. On economics.
Well, whatever others may say, I’m not here to tell you that we’ve abolished the business cycle. Instead, I’ve got a theory: The world has gone topsy-turvy. As Cole Porter put it in the song “Anything Goes”.
Bad news as good?
Could it be that the markets have actually decided that bad news is good? Is it possible that events and ideas that once would have sent markets into a downward spiral are somehow lofting them ever higher? And if so, should investors be perversely hoping for even more bad news?
How would I even test this hypothesis? Maybe by inviting disaster: I could stop flossing! Take up smoking again!
No, bad as those things would be, we need something that afflicts all of society. Maybe we can have more tariffs. After all, trade wars are good, and easy to win. We can make the government totally dysfunctional!
Impeachment? (A mixed bag, that one: To some, it’s good news.) Or maybe even hope for another war? Maybe with Iran? Leading to the Third World War?
Hmm. Maybe my thesis is being tested, after all. But these aren’t things I want to see, so I’ll stick with middling misfortune. Still, there might be other ways to validate my theory.
I called a certified smart person to find out if my theory is brilliant: N. Gregory Mankiw, an economist at Harvard University.
From 2003 to 2005, during the George W. Bush administration, he was chairman of the Council of Economic Advisers. He’s also an economic hero of mine for a 2007 paper he wrote that suggested we should tax tall people at a higher rate than short people. As a short person, I found that this argument made economics come alive for me. (Unfortunately, Greg didn’t really mean it; he was making a point about things we should and should not fairly tax.)
The first thing he wanted me to understand was that markets have actually been taking some of the bad news into account but are buoyed by other factors. “The news has been mixed,” he said. “The trade war stuff has been bad for the markets, but the tax cut stuff has been good for the markets.” The economy has continued to grow, and unemployment has somehow reached historically low levels without setting off inflation. “That’s a bit of a puzzle,” he admitted.
“If there’s one big thing I would emphasise, it’s how little economists know,” he said. “We are really, really bad at predicting.”
That lack of forecasting ability should not be so surprising, he said; it’s not confined to economists. Mathematicians know an awful lot about numbers, he said, but “you wouldn’t ask them what’s the next winning Lotto number.” And, he added, “the inherent unpredictability is not going to go away.”
Testing the curve
This was fascinating — who doesn’t love a conversation about macroeconomics? But it still wasn’t helping me understand whether I was about to revolutionise economic theory with the Schwartz curve, which posits an inverse relationship between good news and good market returns. Or something like that.
As improbable as it sounds, was my idea not brilliant? Even, perhaps, stupid? I’ve been called an idiot before. More often than you might think! I can take it.
He chose his words carefully. “I would never call anybody stupid,” he said, “but I would say that the idea is probably not brilliant.”
He explained, “It almost never makes sense to say, “This is a good time to buy, or this is a good time to sell,” because we literally never, ever, ever know.”
That’s the folly of day trading, he said: Trying to time the market is a game almost nobody wins. Buy and hold, he said, “is the right way to go.”
Greg was no fun. But he wasn’t wrong. I don’t actually buy and sell individual stocks myself. Like most investors, my savings are largely parked in low-fee index funds. I’m chicken.
On the other hand, it’s a relief to know that I don’t have to be out there wishing for disasters to get rich. Writing about climate change, as I do in my day job, is already disastrous enough for me.
— New York Times News Service