It was announced this week that Richard Thaler won this year's Nobel Prize in Economics. Thaler, 72 and a professor at the University of Chicago, is one of the founders of the controversial field of behavioral economics. He won this year's Nobel for his research on how human weaknesses such as a lack of rationality and self-control can impact financial asset prices.
In a wide ranging interview with Bloomberg today, when asked about the U.S. Stock Market, Mr. Thaler said the following:
“We seem to be living in the riskiest moment of our lives, and yet the stock market seems to be napping,” Thaler said, speaking by phone on Bloomberg TV. “I admit to not understanding it.”
Thaler continued, “I don’t know about you, but I’m nervous, and it seems like when investors are nervous, they’re prone to being spooked.” However, Thaler said, “Nothing seems to spook the market” and if the recent gains are based on tax-reform expectations, “surely investors should have lost confidence that that was going to happen.” Thaler added that he didn’t know “where anyone would get confidence” that tax reform is going to happen. “The Republican leadership does not seem to be interested in anything remotely bipartisan, and they need unanimity within their caucus, which they don’t have.”
Bottom line: The foremost authority on behavioral economics is "nervous" about the U.S. stock market in this, the riskiest moment in our lives!
A daily chart sell signal was triggered in my computer trading system for the Russell 2000 Small-cap ETF (symbol IWM) at yesterday's close, October 9th. Please see chart below.
Russell 2000 Index ETF (symbol IWM) with Computer-generated Buy & Sell Signals
While most major indexes have posted record highs this week, volatility, as measured by the VIX at the CBOE, posted record lows. There is a calm, almost eerie feeling about this latest stock market advance. Some Wall Street pundits are now suggesting that we are in a "melt up" phase bolstered by positive talk about tax reform (tax cuts, no real reform) and strong corporate earnings reports expected immediately ahead. In mid-October 1987, U.S. stock prices started to retreat. The Federal Reserve had been raising interest rates for several quarters (just like now), and valuations were considered "stretched" after advancing for more than 5 years (just like now). Corporate earnings were robust (like now) and "Main Street" America was relatively comfortable (like now) after 5 years of economic growth which followed the 1982 recession. No one could have imagined the carnage which would take place on October 19th, 1987 when the Dow Jones Industrial Average lost 23% of it value in a single day. Was their a catalyst that triggered the Crash of 1987? Even though I was a trader in the popular OEX contract at the CBOE at that time, I still can't say for sure what caused that unprecedented Crash. On Friday, October 16, 1987, the trading day before the crash, there were reports that Iranian gunboats fired upon U.S. warships in the Persian Gulf. Maybe this was the spark that triggered Monday's deluge of selling. Most reports of the day and subsequent analysis point to a trading strategy at the time called "portfolio insurance" (basically, everyone was long, without fear!). Today's popular "risk parity" strategies have the look and feel of the "portfolio insurance" scheme of 1987. And later this week, President Trump is expected to refuse to re-certify the Iran Nuclear Deal (Iran again, just like in 1987)!
Some say that a 1987-type Crash can't happen today or ever again given the precautions now in place by the exchanges. More importantly, most believe that the Federal Reserve and other global central banks will just step in as "buyers of last resort" if there is any significant downturn in stock prices. And maybe that's so, but how far down will prices have to go before central banks begin their "plunge protection" efforts? We live in interesting times, for sure! Is that a black swan I see on the horizon?
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