Equity markets have to explaining to do, regardless of where you think they are heading. As ConvesrgEx's Nick Colas notes, if bullish, riddle me this: are stocks just going to hop-skip-jump over Fed tapering, U.S. budget battles, a new Federal Reserve Chair, Syria, Greek bailout 3.0, German Elections, and other near term speedbumps? Last time we checked "hope" still isn’t a strategy. And for the bears: Colas asks, how has that been working out for you over the last week of boa constrictor-like squeezes higher? Not so good. In the following note, Colas takes an out-of-the-box approach to explaining the recent rally by looking at some new academic work on the subject of stress. As it turns out, stress is only harmful if you believe it is. Maybe markets have 'learned' that lesson and view all these potential stomach-churning headlines as annoyances, rather than existential crises-in-waiting.
Via ConvergEx's Nick Colas,
Stress gets a bad rap, at least according to some recent psychological studies. The traditional view of psychological/emotional strain and its effect on the human body is pretty straightforward: stress kills. It leads to heart attacks and strokes, can cause severe depression, suicidal thoughts and other significant health problems. Researchers are now re-examining these assumptions, though, with some surprising results. Two studies and one bonus point to consider here:
Researchers from the University of Wisconsin used the 1998 National Health Interview Survey to develop a dataset of 28,753 people, focusing on self-reported stress levels and the participants’ judgment about how much impact that stress had on their health. They then cross referenced the people in the survey to death records through 2006. The individuals who reported both experiencing “A lot” of stress and that it had a significant impact on their day-to-day health were 43% more likely to have died over the 8 years encompassed by the study’s data. Conversely, people who experienced moderate or “A lot” of stress and didn’t report it changing their underlying health had no incremental mortality rates versus the underlying average.
From the labs of University of Rochester, UC – San Francisco and Harvard: “Physiological changes that co-occur with stress are not necessarily bad.” A recent paper (link below) from researchers at these institutions offers up a summary of recent work on the topic of “Arousal reappraisal”. Essentially, with training, individuals can learn to accept their body’s natural reaction to sudden strain (perspiration, a spike in blood pressure and heart rate, etc.) as a welcome aid to performance – essentially the “Fight” response rather than just the call to “Flight”.
Stanford lecturer Kelly McGonigal has a wonderful TED lecture on the topic which reviews these studies and also posits that oxytocin plays a role in stress response. The popular name for this compound is the “Love hormone” and basically it makes you want to bond and connect with fellow humans. Funny enough, though, oxytocin is a stress hormone, released at the same time as adrenalin. It has a pragmatic function, helping to repair the heart muscle damage done by adrenalin, but McGonigal posts that it also encourages the stressed out to seek help from others.
I bring all this up because September is supposed to be a stressful month for investors, and so far it has been about as nerve-racking as a walk to Isabella’s for Sunday brunch on a clear fall morning. The S&P 500 looks set to break out to new highs in another few days, 10-year Treasuries have temporarily halted their forced march past 3%, and even emerging markets show signs of life. If you are bearishly inclined and positioned, it has been a maddening few days. And if you are bullish, well, it feels like you’ve just won at one of those scratch-off lottery tickets – a welcomed but small unexpected payoff when you knew the odds weren’t really in your favor to begin with.
At the same time, absolutely none of the supposed speed bumps of September have any sort of resolution. Just a few of the myriad of problems waiting in the wings:
- The announcement of a new Federal Reserve chair to replace Ben Bernanke
- The pace of the Federal Reserve’s tapering of bond purchases
- German elections and their effect on that country’s desire to act as the restructuring piggy bank for southern Europe
- Any U.S. or other large country’s involvement in the Syrian civil war
- Any further spillover of the Syrian conflict to Iraq, which would take oil prices higher
- The continued drip-drip of earnings revisions to the downside for U.S. public companies
- Any consistently positive money flows into U.S. listed ETFs, with the last week’s positive inflows of $7.4 billion into stock ETFs entirely made up of the prior day’s action
- A still complacent options market that fades every whiff of volatility and pegs the CBOE VIX Index at 13.8 yesterday. The long run average is 20…
The “Easy” explanation to the market’s resilience in the face of all this stress is twofold: hope in an accelerating U.S. economy in 2013/14 and the notion that stocks are still cheap based on earnings expectations of $120+/- for 2014 on the S&P 500. If that is the crux of the argument, then I think September will still prove out its reputation for hair-raising thrills and chills. The fundamental drivers of market volatility – stress, if you will – are still with us. Maybe they are on a short mini-break, but all the points above are valid reasons for near term caution, regardless of the positive tone to trading.
Anyone with a negative take on stocks at this point must, however, consider the possibility that something else is afoot with the most recent bounce higher. The usual criticism that the Fed’s QE program puts extra money into the stock market holds less sway now that we know the direction of such flows is on the wane. Bond market volatility has died down as well, so that storyline isn’t quite as spooky. Fake Chinese economic data snookering investors into plowing capital into emerging markets? That was a good call – in 2006…
Instead, what if investors have learned how to process news-related stress better than they used to? I know I risk anthropomorphizing capital markets with that thought, but it certainly seems that scary headlines – or the promise of such – have lost some of their power to create fear and stress. There is no denying that we have a whole host of things that should be creating market stress and very few signs that these actually have an impact.
To close out this thought, we will cycle back to the psychological literature on stress and how humans cope with it. Recall that the recent work points to a more nuanced approach to analyzing the health effects of stress. It isn’t feeling emotional strain that harms you; it is believing that it can harm you which does the damage. If investors have learned that lesson and put markets into a more quiescent state, so be it. And if that is overly optimistic, then they will have ample opportunity to exercise some stress management when the headlines begin to matter again.