Question from a reader:
I’d be very interested to hear your thoughts about what we should conclude about the efficient markets hypothesis based on the recent events.
I’ve always been convinced in the truth of (semi-strong) EMH and handled my finances accordingly. However, my conviction was greatly shaken by the recent events. It seems clear that in the weeks preceding the financial crash earlier this month, the markets had completely ignored the evidence of the coming COVID-19 pandemic and the shock it would cause.
One month ago, on March 1, I sent the following to family members.
Folks,
Here are my thoughts on the stock market. Basically, I think that there is a chance that it could fall much further, and my own reaction will be to sell some stock market mutual fund shares and park them in a money market fund for a while. You might want to look into doing that with some of the stock market mutual funds you have in retirement accounts–shift them from stock mutual funds to money market funds, still within the retirement account family. No tax implications from doing so.
My thinking is that with the coronavirus, the number of shutdowns and travel restrictions is going to increase. The economic adversity this is likely to cause is not something that can be mitigated by the Fed, even though some people seem to attribute magical powers to the Fed..
If I thought that people would get over the initial panic and get back to normal soon, I would not be so pessimistic. But my guess is that instead the panic will get worse. even if the virus itself were to turn out to be a non-event. Hence, the economic consequences of the reductions in trade, travel, and tourism will still be quite severe.
My $.02
This was very unusual for me. I cannot remember ever offering market timing advice before. Incidentally, the first big market move after I sent this was the huge “Biden rally.” So for a couple days I looked pretty bad.
My general view of the Efficient Markets Hypothesis is that I don’t believe it, but I act as if it is true. I treat the market as ignorant, so I do not interpret stock market movements as if they forecast the economic outlook. But I figure I am at least equally ignorant, so I almost never try to outguess the market.
If we are back to me being equally ignorant, then it probably would make sense to get back in. But I have such a negative view of the stimulus compared to the Wall Street view that I am willing to wait a while for proof that I am the one who is stupid.
On a somewhat related note, some angry commenters asked me where I am putting my wealth in light of my post on the inflation virus, with which they vehemently disagreed. I am glad that so many people refuse to believe the inflation scenario, because that gives me more time to think about it. The hard assets that I might want to buy are going to remain cheap for a while.
I know that there are inflation-indexed Treasury securities (TIPS), and they may turn out to be the best choice, but I am not sure. Remember, what I foresee is a scenario in which the government is printing money as a last-ditch desperate attempt to pay its bills. Owning the debt instruments of a government in such dire straits does not strike me as risk-free.
“I know that there are inflation-indexed Treasury securities (TIPS), and they may turn out to be the best choice, but I am not sure. Remember, what I foresee is a scenario in which the government is printing money as a last-ditch desperate attempt to pay its bills. Owning the debt instruments of a government in such dire straits does not strike me as risk-free.”
The fox is guarding the henhouse. Never trusted TIPS. Though not necessarily believing in hyperinflation, if I did wouldn’t use TIPS. The government controls the CPI calculation.
For whatever reason, inflation these days shows up in asset inflation rather than CPI inflation.
Bravo for at least talking about investment actions. It’s the only real truth I suppose.
At FRED, the 10-Year Breakeven inflation Rate series is T10YIE – the difference between 10 year bonds and 10 year TIPS. It’s been trending down from the recent high of 2.2% for 18 months, and hit a low unseen since January of 2009 of 0.5% on March 19th. It climbed up all the way to 1.07% on Thursday, March 26th, and then after the CARES Act became law the next day, has declined to 0.87%. Since 10 year bonds are only paying 0.7% right now, that means TIPS are trading for negative rates (about what JGBi does in Japan).
Put another way, the TIPS market expects inflation to be negligible over the whole next decade, and that the CPI index in 2030 will only be 9% higher than it is today, despite all the helicopter dropping, debt binging, and credit takeover splurging and so forth.
Except perhaps for the MMT crowd – who will never be specific enough to be proven wrong when inflation is low, and the Market Monetarists – who can’t be proven wrong no matter what happens, by definition – this result is pretty odd by most prevailing monetary theories – including ones based in social psychology – and warrants a special explanation.
I suspect that Scott Sumner will switch Derangement Syndrome gears to focus on the Fed like a laser again.
Isn’t the conventional wisdom that precious metals provide protection during periods of inflation? There are several ETF’s that track the price of gold.