Published September 20, 2019
Finance, and investing even more so, are resting on the foundation of human emotion. How much a stock is worth certainly has some underpinning in the company’s earnings. But perhaps more important is the price-earnings or P/E ratio, which is how much investors are willing to PAY for those earnings. If Amazon’s investors are willing to pay 50 times earnings for the stock, that makes the company stock much more valuable than if they are willing to only pay 10 times earnings. How much investors are willing to pay is a largely emotional response, framed with ever-shifting justifications and analysis, of course. Expanding that emotional response to the broader economy is the subject of a recent article by economist Robert Shiller, published in the New York Times, and also part of his forthcoming book. Herewith is Dr. Shiller’s article:
“When will the next recession arrive?
Economists are evaluating such factors as President Trump’s endlessly shifting tariff policy, the monetary policy of the Federal Reserve and other central banks, and such “leading indicators” as the yields in the bond market.
It is good to look at these things. They provide insights about the state of the markets and the economy, but they have severe limitations as forecasting tools. This approach will not produce a definitive advance reading of a major shift from growth to contraction: a recession.
Forecasting such a shift is extremely difficult. But if we are to have a chance at success, it is critical to insert into the discussion another factor entirely: an examination of the popular narratives that may be infecting individual economic decision-making.
The probability that a recession will come soon — or be severe when it does — depends in part on the state of ever-changing popular narratives about the economy. These are stories that provide a framework for piecing together the seemingly random bits of information that one picks up from friends, the news or social media.
For consumers these narratives affect decisions on whether to spend or save, whether to take a demanding or an easy job, whether to take a risk or stick with something safer. For business people the prevailing narratives affect deliberations on whether to hire more help or lay off employees, whether to expand or retrench or even start a new enterprise.
For most people, such important decisions are fraught with ambiguity and uncertainty. Hardly any of us have precise formulas to decide our plans. So we allow ourselves to be influenced by the emotions, theories and scripts suggested in the stories we hear from others.
Fortunately, the widespread digitization of text, combined with enhanced capabilities for natural-language processing, is beginning to give us new insights into the history of economic narratives. We are beginning to develop a new economics, one that studies these changing economic stories and metaphors systematically.
In my new book, I describe narratives that can periodically surge into epidemics and are capable of changing the economy’s direction or of turning small booms and recessions into big ones.
These narratives cluster around several issues:
■ Public confidence or the lack of it.
■ Social norms regarding extravagance or modesty in consumption.
■ The rise or fall of monetary standards of value.
■ The replacement of manual workers by machines.
■ The threat of artificial intelligence to all human labor.
■ Real estate booms and busts.
■ Stock market bubbles.
■ Profiteering by big business.
■ Wage-price spirals that are pinned on labor unions.
Changes in the current environment may cause a subtle mutation in these perennial stories, causing them to go viral and sometimes increasing their contagious effects or extending the period in which they expand. Much as epidemiologists study infectious diseases, we economists can study the spread and transformation of these powerful stories.
The last recession 10 years ago was exceptionally severe, and it is worth examining closely for insights into how the spread of economic narratives drove human behavior.
It now appears that while Sept. 15, 2008, was a logical moment for the start of a panic, that’s not really what happened. That was when Lehman Brothers, an old-line investment bank, failed, and while this was a major economic event, the evidence suggests that it did not foster a viral narrative among the broad population.
Since Lehman was an investment bank, and did not accept deposits from small savers, most people weren’t much moved by its demise. Instead, the big change seems to have come on Sept. 25, 2008. That was when the government seized Washington Mutual — a giant savings and loan association, known as WaMu, that had suffered a sudden mass exodus of depositors — and sold its assets to JPMorgan Chase for $1.9 billion.
That event was often seen to resemble the Great Depression and the collapse of the banking system in 1933. People feared the possibility of spreading bank failures and therefore of personal tragedies.
The public was transfixed when President George W. Bush spoke from the White House Rose Garden on Oct. 10, 2008, about the risk of a serious economic downturn.
While Mr. Bush did not utter the word “depression,” he used language that closely resembled that of the first inaugural address of President Franklin D. Roosevelt in 1933, perhaps the worst time of the Great Depression.
Roosevelt’s memorable words, “The only thing we have to fear is fear itself,” became, in Mr. Bush’s Rose Garden speech, “Anxiety can feed anxiety.” The New York Times noted that parallel then. It seemed to many people, in real time, that the Great Depression might be repeating itself.
Even before Mr. Bush’s speech, Great Depression narratives had been emerging strongly. For example, the number of articles in the ProQuest News & Newspapers database containing the words “Great Depression” rose five-fold from 2007 to 2008. The term, with its emotional resonance, had exploded into an epidemic.
In contrast, other big historical events, like the panic of 1907, have been almost totally forgotten by the public and are unlikely to develop into a big new epidemic.
But the Great Depression narrative is still alive, though it does not dominate at the moment. President Trump’s exuberant speeches, if one believes them, still encourage big spending and confidence. Yet older, troubling narratives are waiting to become viral again.
New crises that shake up the economy often surprise economists because no exogenous cause appears to be a sufficient explanation for a downturn. People begin to suddenly frame current events in the context of stories they had heard many times before.
This may seem puzzling until we realize that an old narrative has renewed itself in an epidemic, and people have begun to respond reflexively in their day-to-day decisions. If enough people begin to act fearfully, their anxiety can become self-fulfilling, and a recession, sometimes a big one, may follow.”
At TimingCube, we have found that emotion is the enemy of successful investing. Our models, here and also at our sister site, FP Research, are meant to REMOVE emotion from our investing decisions. We sleep better knowing our models are watching the market’s action and will put us on the right side of the investing equation.
Market Update
This week investors looked to another Federal Reserve meeting and expectations for further reductions in the Fed’s short-term interest rate target. The reduction in interest rates has supported markets as global economic uncertainty swirls. But Monday’s trade was dominated by a +12% surge in oil prices after a weekend drone strike on Saudi Arabia oil infrstructure. Stock prices were little moved by the oil market turmoil with the S&P 500 only slipping -0.3%. Stocks regained the loss in Tuesday’s session with the Saudis expressing optimism that oil supply disruptions would be short-lived. The Saudi government has been working toward an IPO of a portion of the national oil company, known as Aramco. Thus, there is even more incentive for the Saudis to maintain production and a positive outlook. U.S. economic data released Tuesday showed a rebound in August after some weakness in July, further supporting stocks. Wednesday brought the expected 0.25% reduction in the Fed’s short-term interest rate target. The subsequent comments from Fed Chair Powell, particularly in addressing recent overnight monetary trade issues, seemed to satisfy markets, leaving stocks unchanged on the day after an initial dip on the rate news. A jump in housing starts and an announcement by Microsoft (MSFT) of a dividend hike and stock buyback program both served to support stocks Thursday. However, stocks couldn’t maintain earlier gains and closed little changed once again. China-U.S. trade talks Thursday and Friday perhaps kept investors on the sidelines throughout the week, contributing to the flat trading. Friday afternoon brought a slightly negative note from the trade talks as a visit from the Chinese delegation to U.S. agriculture representatives was cancelled. Stocks slid -0.5% on the news to close the week with a mildly negative tone.
Stocks ended their weekly winning streak at three with this week finding the S&P 500 (SPY) repelled by the 3000 mark to close down -0.48% at 2992. The Nasdaq 100 (QQQ), more sensitive to the trade talks as a market index, fell -0.90%. Smallcap stocks (IWM), after their best week of the year, gave back -1.20% this week to remain unable to break free and clear of their longstanding trading range.
Warm wishes and until next week.