December Market Update
Last week was a tough one in the markets as taper fears, once again, in that tired refrain, pushed the indices down. The markets are still in decidedly heady territory for the year, up 27% as of Friday’s close.
Given the holiday season, we thought we’d try to express our concerns a little more festively this month.
Dashing through the Dow
In a market oh so gay
O’er the highs we go
Laughing all the way.
New records Fed does bring
Claiming policies right
What fun it is to see records ring
A surging market alright!
Ohhhh, Taper talk, taper talk,
Bernanke goes away.
Oh what fun it is to ride
the S&P today, hey!
Taper talk, taper talk,
Yellen saves the day!
Oh what fun it is to ride
the Russell 2000 today, hey!
So can the Fed pull it off? Taper without market tantrums? To answer that, let’s look at one of their most important tools, forecasting. Economists are often expected to answer the seemingly simple question, “What will happen to the economy in X period of time if we do Y?” Much fun was had post financial crisis mocking anyone with a title even remotely resembling an economist, as conventional wisdom declared the profession all but dead due to its reported failure to see the impending doom. First, it is absolutely false to say that no economist predicted the financial crisis. Many economists and those in financial services predicted the crisis years in advance. They were typically mocked as fools and in the case of Dr. Michael Burry, sued by investors in his fund Scion Capital, until the inevitable collapse occurred and his remaining clients enjoyed incredible gains, making him the stuff of legends, (hat tip to Chris Brown of Aristides Capital for reminding me of this story). Second, those who got it right were ridiculed or worse because they were unable to predict when the crash was going to occur.
To think that any economist or organization, like the Federal Reserve, can predict with any degree of accuracy the how and when of economic events and manipulations is fool’s wish. I am going to paraphrase the best description of why this is from Russ Roberts, of Stanford University’s Hoover Institute. An economy is a living thing, much like a complex ecosystem where competition and emergent order create a complex interaction of organisms and their environment. We do not expect a biologist to forecast how many squirrels will be alive in ten years if we increase the number of trees in the United States by 20%. A biologist would laugh at you. But that is what people ask of economists all the time. Economists should be honest and say that the tasks they are often asked to do are outside the scope of economics as we know it and perhaps outside the scope of economics as it will ever be known.
Bottom Line: While assuring the markets they know what they are doing, the Fed’s track record, (like most of economics) of foreseeing problems and being able to prevent disasters is unimpressive. Investors be warned.
