Efficient Markets Hypothesis

Why PIMCO Thinks "The Bursting Bubble" Is Not The Biggest Risk

Getting out of a Liquidity Trap with monetary policy playing the lead role necessarily involves a Dornbuschian sequence of rational overshooting: The Fed must drive up Wall Street prices, which move quickly, so as to get to Main Street prices that move up slowly, most importantly, wages. This sequencing implies that Wall Street prices must become very rich relative to Main Street prices in order to achieve so-called escape velocity from the Liquidity Trap. At the transition point, Wall Street prices will be rationally “overvalued” relative to their long-term “fair value.” The dominant risk for Wall Street is not bursting bubbles, but rather a long slow grind down in profit’s share of GDP/national income. And you can stick that into a Gordon Model, too! Bonds and stocks may at present be rationally valued, but borrowing from the lyrics of Procol Harum’s Keith Reid: Expected long-term returns are turning a more ghostly whiter shade of pale.

On The Wisdom Of Crowds (And Madness Of Mobs)

Fear, like greed, makes people, and that would include investors, behave irrationally. Two major equity bear markets in the last 13 years have traumatized investors. The belief in Modern Portfolio Theory in general and the Efficient Markets Hypothesis (EMH) in particular has been shaken and finance theory will have to be re-written. So, Absolute Return Partners' Niels Jensen asks, what is it specifically that has changed? Human behavior certainly hasn’t. Greed and fear have been factors to be reckoned with since day nought. When faced with the unknown, people (in this case, fund managers) will use whatever information they can get hold of. Hence we shouldn’t really be surprised that fund managers extrapolate current earnings trends when forecasting future earnings, despite the evidence that it is a futile exercise. Occasionally, the Wisdom of Crowds turns into the Madness of Mobs and all rational behavior goes out the window. History provides many examples of that. EMH is entirely unsuited to deal with froth. What made economists love the EMH is that the maths behind it is so neat whereas the alternative truth is a little messy.

Head Of The Fed's Trading Desk Speaks On Role Of Fed's "Interactions With Financial Markets"

In what is the first formal speech of Simon "Harry" Potter since taking over the magic ALL-LIFTvander wand from one Brian Sack, and who is best known for launching the Levitatus spell just when the market is about to plunge and end the insolvent S&P500-supported status quo as we know it, as well as hiring such sturdy understudies as Kevin Henry, the former UCLA economist in charge of the S&P discuss the "role of central bank interactions with financial markets." He describes the fed "Desk" of which he is in charge of as follows: "The Markets Group interacts with financial markets in several important capacities... As most of you probably know, in an OMO the central bank purchases or sells securities in the market in order to influence the level of central bank reserves available to the banking system... The Markets Group also provides important payment, custody and investment services for the dollar holdings of foreign central banks and international institutions." In other words: if the SPX plunging, send trade ticket to Citadel to buy tons of SPOOSs, levered ETFs and ES outright. That the Fed manipulates all markets: equities most certainly included, is well-known, and largely priced in by most, especially by the shorts, who have been all but annihilated by the Fed. But where it gets hilarious, is the section titled "Lessons Learned on Market Interactions through Prism of an Economist" and in which he explains why the Efficient Market Hypothesis is applicable to the market. If anyone wanted to know why the US equity, and overall capital markets, are doomed, now that they have a central planning economist in charge of trading, read only that and weep...

ilene's picture

The US is now being run by an oligarchy, with lip service being paid to the electorate in allowing the people to vote for the candidates that the parties and the powers will put forward. There will be no recovery for the middle class until they assert themselves. I know I have stated this often in my tag phrase, “The banks must be restrained…”

Leo Kolivakis's picture

The prospect of major hedge funds and mutual funds getting redemption notices makes traders on Wall Street very nervous. This is the type of stuff that makes me nervous too because you don't know how it's going to play out. It might turn out to be nothing, and blow over, or it might snowball and wreak havoc in financial markets.

James Galbraith On Economic Theory As A Disgraced Profession

Some appear to believe that "confidence in the banks" can be rebuilt by a new round of good economic news, by rising stock prices, by the reassurances of high officials – and by not looking too closely at the underlying evidence of fraud, abuse, deception and deceit. As you pursue your investigations, you will undermine, and I believe you may destroy, that illusion. But you have to act. The true alternative is a failure extending over time from the economic to the political system. Just as too few predicted the financial crisis, it may be that too few are today speaking frankly about where a failure to deal with the aftermath may lead. In this situation, let me suggest, the country faces an existential threat. Either the legal system must do its work. Or the market system cannot be restored. There must be a thorough, transparent, effective, radical cleaning of the financial sector and also of those public officials who failed the public trust. The financiers must be made to feel, in their bones, the power of the law. And the public, which lives by the law, must see very clearly and unambiguously that this is the case. Thank you. - Professor James Galbraith

A Return To Rate Normalcy Will Cost The Fed Hundreds Of Billions; The Fed Will Go "Negative Carry" In 2015: D-Day For America

Today, Chris Whalen's Institutional Risk Analytics carries a fantastic piece by Alan Boyce, in which the author picks up where we left off some time ago in deconstructing the DV01 of the Federal Reserve's SOMA. As a reminder, using Jefferies data, we observed that the Fed's DV01 on its balance sheet is about $1 billion (the potential unrealized profit/loss for every basis point move in interest rates, and with ZIRP here, rates can only go up, so make that just loss without the profit) . Alan Boyce, a former Fed member, CFC executive, and Soros portfolio manager, provides a more granular analysis of the Fed's holdings and comes up with an even scarier DV01: one that is 50% higher, or a $1,509 million/bp. This means that the Fed faces a "$75 billion loss for the first 50 bps move in the markets." As before, it is obvious why the Fed will do everything in its power to keep rates as low as possible for as long as possible, as the vicious cycle that will begin with increasing rates will make all future press releases of how much money the US taxpayer has "made" on the US' bailout of the mortgage industry far more problematic. Boyce also discusses how precisely it is that the Fed has managed to maintain rates at current record low levels for so long, what the cost of an appropriate hedging portfolio would be, and, critically, the implications of what will happen when markets realize that we are caught in a state of artificial suspended and Fed-endorsed animation. The primary conclusion: look for interest rate volatility to surge by 50% even as the Fed scrambles to cover hundreds of billions in losses in its portfolio sooner or later. Boyce's summary is basically that the countdown to the end of the Fed QE regime is now on: "If you look at forward fed funds (Eurodollar curve less basis swap),
the FRB will go negative carry in March 2015, where 3 month financing
rates are forecast to be over 5% (just gets worse and worse from
there). The point here is that mark-to-market accounting is an
iron law. You cannot escape the losses just because you do not report
If the FRB loses $200 billion on mark to market,
there will be $200 billion LESS that they remit to the Treasury
Department every year. That will require legislation to either raise
taxes or lower spending by $200 billion (or run up bigger Federal debt
to be paid back by another generation)."
Must read analysis.

inoculatedinvestor's picture

This week's link fest has a common theme: the unintended consequences of government actions. I include the US Fed in the government category for obvious reasons. Between Greenspan’s beliefs in efficient markets, Bernanke’s Great Moderation, tax credits for housing and the Fed’s current unlimited money printing, it is amazing how much damage can be done by the wrong ideas and policies.