Known Unknowns

Writing about unknown unknowns would be more interesting, but I don’t know what they are. Instead, I will focus here on some unknowns that have been bothering me. Most have to do more or less with the efficient market hypothesis, whose logic I find compelling and whose exceptions I find confounding.

Most recently, Chairman Bernanke, in his last two post-FOMC press conferences, said what most people in the markets expected him to say and what the logic of the situation called for. Given the still weak economy the present degree of quantitative easing ($85 billion of security purchases per month) would be maintained, but, if the economy strengthens sufficiently, that pace of purchases would be tapered down in the next several months and, when the economy is healthy enough to be on its own, the purchases would be ended. Short-term Interest rates would remain low some time after that. While one of the medicines would be reduced and eventually withdrawn, the economy would be much stronger before it happens.

First, I have a hard time understanding why the markets take that sensible approach so negatively, especially since it’s been articulated so frequently in the past. Second, why does it take two days to move the markets to their new, more appropriate, levels? Actually, it’s four days: two after each press conference. Do the first two days not count because the market subsequently regained some lost ground? And why does the advance after the first two not presage an advance after the subsequent two and thus render it moot?

Efficient markets help explain why active investors have a hard time beating the market and why most usually don’t. Yet, a still-huge financial sector has a vested interest in clinging to the notion that homework and skill can lead to repeatable success, whether they believe it deep in their hearts or not. But, what happened to the rule of buying on the rumor and selling on the news. That makes sense, but day after day we see markets appear to be surprised by the obvious or the telegraphed.

I’ve always been fascinated by the fact that smart, well-educated, well-trained professionals aren’t necessarily better investors than dopes like me who assume that each stock is already priced to reflect all knowns. It does make life easier, however, to assume that others have done your homework for you.  It’s like choosing your lane on the freeway. You can maneuver in and out of lanes to enhance your relative position, but as often as not you end up about where you would be if you stayed in the same lane. The others do your lane-switching work for you.

Chairman Bernanke must be tearing his hair out. He offers to help as long as it’s needed and to quit only when it’s not and we respond with sell, sell, sell.

Comments (14)

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  1. donninator says:

    I’m fascinated by the fact that smart, well-educated, well-trained academia aren’t necessarily better policy makers than dopes like me who assume that the market will set interest rates appropriately and efficiently.

    • Dewaine says:

      Exactly. The masses of dopes collectively determine value. The smart, well-educated and well-trained think that they do.

      • Sam says:

        Hmmm, it’s interesting to see how human nature works in modern times. The more we evolve, the more complex we try to economize our resources and the less sense it makes in the end.

  2. Tony says:

    I am not an economist nor have I studied economics through an undergraduate degree course. However, I must say I am right there with you, Bob:

    “That makes sense, but day after day we see markets appear to be surprised by the obvious or the telegraphed.”

    • Sammy says:

      I think he made a good point in showcasing you don’t have to be a PhD economist to understand the market in it’s pure nature would set interest rates efficiently.

  3. Greg Magnus says:

    People are extremely fickle. They don’t respond to reasonable information.

    • Dewaine says:

      People are fickle, but what is reasonable is subjective. I think that people are acting rationally, but their actions are conflicting with what we think is rational.

  4. Champion says:

    I feel that if people constantly react this way to news regarding monetary policy, why aren’t they changing their approach to presenting it?

    • King Of Sealand says:

      Exactly. I feel that presentation is key when preserving the market. Now I am not advocating that they change the truth, but I am advocating that they present the truth in the best manor possible.

    • Dewaine says:

      True. People must understand what they’re saying differently than what the Fed thinks it means. They need to stay one step ahead of us by using ever-evolving language that way we never know what they are really doing.

  5. Jim Moser says:

    I’ll take a stab at Mr. McTeer’s question. The known unknown is how other investors are going to respond to new information. Taken severally, each investor can anticipate the effect of an announcement. It is far more difficult to anticipate the effect the announcement will have on other investors. What must be digested is both the immediate price response and discussions about the price response. Those create a response to the response and so it goes until the energy created by the announcement is fully dissipated.

  6. mike moran says:

    Sticking with the question of the market reaction, will through out 2 points. One both stock and bond markets had been up this year. If the stock market had been down 10% instead of around 15%, different reaction. It needed a correction, this is the excuse.

    Also, to Jim’s point above (or a concrete example of Jim’s point), the stock market in large part reacted to the bond market. So the question is not why the stock market reacted to predictable news as it did, because it was reacting to the bond market. The question is why did the bond market react to the predictable news the way it did?

  7. Benjamin Cole says:

    Well, there is jiggle-wiggle on a daily basis, and it may be related to something other than the Fed. Maybe something happening in China, for example.

    You know, I read some blogs that ascribe everything under the sun—gold prices, global interest rates, commodities prices, housing etc—to something the Fed did.

    But corn went up in price due to ethanol. Oil prices went sky high in 2008 on incredible demand, and scarcity (think OPEC and the roll-call of thug nations that control most of the world’s oil).

    Indians and Chinese are the world’s biggest buyers of gold. Their incomes are rising. So gold prices are going up. The Fed? Yeah, when the Fed went to QE, gold prices cracked. Explain that. I mean, without laughing.

    It ain’t the 1970s anymore.

    The Fed is not the only central bank in the world, and the BoJ and PBoC represent economies that, together, are larger the USA economy.

  8. Toby says:

    What an interesting analogy! Multi-levels


    It’s like choosing your lane on the freeway. You can maneuver in and out of lanes to enhance your relative position, but as often as not you end up about where you would be if you stayed in the same lane. The others do your lane-switching work for you.