Hussman (Halloween Edition): Superstition Driving Markets

wall-street-halloween-jokeThose who read John Hussman won’t be surprised by his current bearish viewpoint, David Rosenberg he is not.  His recent missive packs some Halloween punch:




In 1948, the behaviorist B.F. Skinner reported an experiment in which pigeons were presented with food at fixed intervals, with no relationship to any given pigeon’s behavior. Despite that lack of relationship, most of the pigeons developed distinct superstitious rituals and maneuvers, apparently believing that these actions resulted in food. As Skinner reported, “Their appearance as the result of accidental correlations with the presentation of the stimulus is unmistakable.”

Superstition is a by-product of the search for patterns between events – usually occurring in close proximity. This kind of search for patterns is essential for the continuation of a species, but it also lends itself to false beliefs.

Most people don’t realize the following:

Rather, the crisis ended – and in hindsight, ended precisely – on March 16, 2009, when the Financial Accounting Standards Board abandoned mark-to-market rules, in response to Congressional pressure by the House Committee on Financial Services on March 12, 2009. The decision by the FASB gave banks “substantial discretion” in the values that they assigned to assets. With that discretion, banks could use cash-flow models (“mark-to-model”) or other methods (“mark-to-unicorn”).

Hussman Superstition wmc131028a

The misattribution of cause and effect in 2009 created the Grand Superstition of our time – the belief that Federal Reserve policy was responsible for ending the financial crisis and sending the stock market higher. By 2010, this narrative was so fully accepted that the Fed’s announcement of further “quantitative easing” was met by equally great enthusiasm by investors.

What is QE actually doing?

Still, the rate of monetary growth has been breathtaking in recent years, relative to history, so it’s important to understand the mechanism by which QE has exerted its effects more recently. Simply put, quantitative easing impacts stock prices by creating a mountain of zero-interest cash that must be held by someone at each point in time. The hope and mechanism behind QE is to force those cash holders to feel so distressed that they reach for yield in speculative assets they would otherwise choose not to hold. The process ends at the point where investors are indifferent between holding zero-interest cash and more speculative securities such as long-term bonds or stocks. At this point, every speculative security is priced to achieve the lowest possible risk premium that investors are willing to accept. And here we are.

The Fed in recent history:

Recall that stock prices collapsed by half in 2000-2002 and again in 2007-2009 despite aggressive monetary easing. A friendly Fed doesn’t help stocks to advance except in environments where investors are alreadyinclined to accept risk. To believe that QE makes stocks go up because “it just does” is superstition.

Superstition always ends in failure:

“In sum, the financial markets presently rest on a spectacular and exaggerated superstition about the power of Fed policy to impact the financial markets and the real economy. This superstition was born of crisis, and is likely to end in crisis, as investors re-learn what they should have learned about Fed policy in the 2000-2002 and 2007-2009 plunges.”

And finally:

Probably the most challenging aspect of quantitative easing is that, particularly since late-2011, overvalued, overbought, overbullish conditions usually associated with severe market losses have instead been associated with even more extreme speculation.


You can read the whole post at The Grand Superstition.



Leave a Reply