My not-so-profound thoughts about valuation, corporate finance and the news of the day! Tuesday, June 6, 2017 A Tale of Two Markets: Politics and Investing! "It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to Heaven, we were all going direct the other way.” That Charles Dickens opening to The Tale of Two Cities is an apt description of financial markets today. While disagreement among market participants has always been a feature of markets, seldom has there been such a divide between those who believe that we are on the verge of a massive correction and those who equally vehemently feel that this is the cusp of a new bull market, and between those who see unprecedented economic and policy uncertainty and market indicators that suggest the exact opposite. Is one side right and the other wrong? Is it possible that both sides are right? Or that both sides are wrong? The Divergence The investor divide is visible, and sometimes dramatically so, in almost every aspect of markets, from risk indicators to fund flows to consumer behavior. 1. Risk on? Risk off? Do we live in risky or safe times? It depends on who you ask and what indicator to look at. Over the last two decades, the VIX (Volatility Index) has become a proxy for how much risk investors see in equity markets and the graph below captures the movement of the index (and a similarly constructed index for European stocks) over much of that period: VIX: S&P 500, Euro VIX: Euro Stoxx 50 Last year, the volatility measures in both the US and Europe not only took Brexit and the Trump election in stride but they have, in the months since the US presidential elections, continued their downward move, ending May 2017 at close to historic lows. Lest you believe that this drop in volatility is restricted to stocks, you see similar patterns in other measures of risk including treasury yield volatility (shown in the graph) and in corporate bond volatility. This volatility swoon is also not restricted to the US, since measures of global volatility have also leveled off or decreased over the last few months. In fact, the volatility in currency movements has also dropped close to all-time lows. In sum, the market seems to be signaling a period of unusual stability. That is at odds with what we are reading about economic policies, where there is talk of major changes to the US tax code and trade policies, signaling a period of high volatility for global economies. The economic policy uncertainty index, is an index constructed by looking at news stories, CBO lists of temporary tax code provisions and disagreement among economic forecasters, has been sending a very different signal to the market than the market volatility indices: In the months since the election, the indices have spiked multiple times, breaking through records set during the 2008 crisis. In short, we are either on the cusp of unprecedented stability (at least as measured with the market volatility indices) or explosive change (according to the economic policy indices). 2. Funds in? Funds out? The ultimate measure of how comfortable investors feel about risk is whether they are putting money into stocks or taking them out and fund flows have historically been a good measure of that comfort. Put simply, if investors are wary and risk averse about an asset class or market, you should expect to see money flow out of that market and if they are sanguine, you should see money flow in. In the graph below, we look at fund flows into equity, bond and commodity funds, by month, from the start of 2016 to the April 2017: http://aswathdamodaran.blogspot.com/2017/06/a-tale-of-two-markets-politics-and.html https://www.blogger.com/profile/12021594649672906878
Some people put money in the market when they have a job. And then take it right back out when they lose their job. That's why they say the market goes up when the economy is good. Sometimes people buy stocks when you can't get jack in a savings account. That's why they say low rates are good for the market. What is a contrarian to do? Buy stocks when you get laid off, then sell them when the economy improves and you can get a decent rate on a cd. Not a bad idea if you can afford it.