Please stop telling capital markets what they think

I guess we are supposed * to be all entitled to our own opinion. But people around markets don’t seem content with that. They also need to tell the capital markets what they think.

This has particularly been an issue since the election, with US equities presumably going higher because of Presidente Trompe, even though US markets have lagged the major overseas developed markets and even though stocks Goldman defined as particularly Trump-sensitive have underperformed.

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There have been a couple frights around the Trompe Rally. For example, stocks got set back briefly when it looked like too many Americans would keep their healthcare coverage. But for the most part the Trompe Rally has been robust, people say.   They assume Paul Ryan will eventually cobble together a plan to kill millions, which Trompe will sign, in the end. Or if he can’t do that, at least he will make income maldistribution far worse.

But now here comes contrarian Business Insider to inform us that stocks don’t have the right bead on the economy because stocks “tend to have an optimistic bias.”  The true measure of Trump, then, is the bond market, which is less prone to fads because of a lack of retail participation. And the bond market has been in a funk, which means Trump is maybe not so great after all. Who knew?! I mean, besides the bond market.

There are a couple issues with this perspective. First, it is hard to square equities’ chronic overoptimism with their chronic excess return. I wonder if that guy from BI realizes he just made the equity premium puzzle worse. Second, the idea that bonds are smarter because of a lack of retail participation seems to assume away housing finance, which has occasionally been important.

I would say a simpler story is that stocks have been too pessimistic about the United States, mainly by overestimating the risk the US would go to zero, which ex-post has turned out to be zero.  It was not guaranteed but it is how things worked out. Instead of going to zero, the United States has been the most successful place anywhere ever.  On average, people did not expect that.

I would also say the bond market is less likely to be wrong, in whatever it thinks and with whatever effect, which I would not presume to judge, because the bond market delivers the more influential price. It is not so much that bond price setters are smart as that they are really influential, which usually sets up negative/stabilizing feedback dynamics. In contrast, equity price setters are irrelevant enough to stay really wrong.  We just don’t necessarily know how ahead of time.

In fairness, with Trompe in the White House I too fear an extinction level event. But it is not something you can obviously hedge by lightening up in equities.  (I have anyway, sadly.)  When sitting on a heap of radioactive ash waiting for their skin to fall off, nobody has ever been known to say, thank God I am in Treasuries.

* I have no idea what the origin of that right would be. Rights are tricky.   As I read it, the classical liberal argument is that society works better if we act as though we believe the convenient fiction that the other guy has a right to be wrong.  But that is a bit different from all of us having the right to an opinion.  It would depend a lot on how you formed that opinion. Sitting on the sofa, drinking beer, gritting your teeth and mainlining your priors from the tee vee might not cut it.