Is the Market Rational After All?

For the past decade, attempts to explain the psychology of markets have been dominated by behavioral economics: rather than being rational actors as presumed in classical economic models, humans are often profoundly irrational and prone to cognitive distortions and errors that render their choices anything but rational.

Even the wisdom of crowds–that in aggregate, crowds make better decisions than individuals–is being questioned.

Ironically, while the clinical focus has been on individual irrationalities and frailties, markets have been increasingly controlled by a handful of central planners: central banks and state authorities who are intervening in supposedly free markets (i.e. outright manipulation) to an unprecedented degree.

Central banks are buying trillions of dollars, yuan, yen and euros of assets such as mortgages, sovereign bonds, corporate bonds and stocks to prop up markets in these assets as a means of generating confidence and positive sentiment, and suppressing any downturns by selling volatility (the VIX index).

The VIX (volatility) and the stock market are on a see-saw: as volatility leaps higher, markets sell off, and as volatility declines, complacency enables markets to drift higher.

The VIX has been monkey-hammered lower for months. Every time volatility (as reflected by the VIX) starts creeping up into the danger zone, it is sold, effectively pushing the index back down to “safe” complacency (“no worries, mate”) levels.

So if individuals and crowds are delusional and irrational, how can a handful of central planners not be equally delusional and irrational? the key to understanding market behavior is not human irrationality. Rather, the key drivers in today’s markets are completely rational responses to the incentives created by central planners.

Only an irrational person who wanted to be fired would repatriate billions of dollars in overseas profits to the U.S. and pay 35% in corporate taxes. The only rational response to this disincentive is to find ways to funnel this money into corporate buy-backs that enrich CEOs and other top managers. To do otherwise would be irrational.

if central banks (i.e. central planners) have made it abundantly clear that they will intervene to keep markets aloft, regardless of cost, then the only rational response is buy the dips because central planners will stick-save markets from any panic declines and then push them to new heights.

If central planners routinely hammer volatility down with huge selling, then the only rational response is to align your trades to profit from this ever-present intervention.

This is the market we have now: dominated by delusional, irrational central planners with unlimited powers to create money out of thin air to fund their manipulations.

The only rational response is to trade accordingly: anticipate constant manipulation, anticipate constant bombastic propaganda of the “whatever it takes” variety, and anticipate massive selling of volatility to maintain the ever-so-important illusion that global risks have been disappeared by central banks and central planners.

Until the central planning madness destroys markets’ ability to discover price and allocate capital. Then you end up with Venezuela: a failed state and a broken economy that can no longer feed its people despite the nation’s vast oil wealth.

Volatility has been chosen as a “signaling device” by central planners. A low VIX signals all is well and risk is non-existent, so central planners suppress VIX.

In a world roiled by staggeringly large risks, can VIX be suppressed forever? That’s a difficult question in a market dominated by irrational central planners.

A Radically Beneficial World: Automation, Technology and Creating Jobs for All is now available as an Audible audio book.

My new book is #3 on Kindle short reads -> politics and social science: Why Our Status Quo Failed and Is Beyond Reform ($3.95 Kindle ebook, $8.95 print edition)For more, please visit the book’s website.

This entry was posted in General and tagged , , , . Bookmark the permalink.
  • Jun 1, 2016 5 Stock Charts Show U.S. Debt and Economy Death Cross!

  • cstahnke

    Markets are rational only when they are set up by political authorities to be rational. Currently all markets are weighted to give dramatic advantage to the very richest among us. For example, if you go to rich neighborhoods (where I once lived) you have a great choice for food and other necessities close at hand with always the best produce available and local markets. In poor neighborhoods you have few choices, few markets and poor quality food the same goes for education and services. Markets are always manipulated for the ruling class unless there is a benign political authority which we don’t have.

    Personally, I think the whole idea of a “free-market economy” is ludicrous. There is no such thing as a free-market, never has been such a thing and can never be such a thing. Also there is no such thing as an “economy” as if it was some independent thing–there is only a “political-economy” which brings political power to the equation as I’ve indicated above. The well-off are more powerful than the poor so they have better markets and get better deals, better interest rates and so on and so on. Our “economy” is considered all important because it is an ideological device to keep people enslaved into thinking that their value is based on the cash-value of their economic interactions with others–there is no value outside of that. That particular ideology is called neo-feudalism and is simply not any different in ultimate terms than the old feudal relations–just less secure and more “volatile” meaning more upside and more downside as a system of government. Capitalism moved from feudalism to marrying scientific/technical prowess with a money economy to produce “high” capitalism for 30 years after WWII and we are now, gradually, returning, once again, back to some new feudal order. Good thing, at the moment, we have political instability which could change everything.

    • Know and share this with folks so they can know who is control of everything.

      A surprisingly small number of corporations control massive global market shares. How many of the brands below do you use? It is a Small World at the Top, and the largest banks hold a total of $25.1 trillion dollars or enough to fund the federal U.S. government for over 7 years or roughly $3500 per person on earth.

      Which Corporations Control the World?

  • WillDippel

    Here is an article that explains why returns on both stocks and bonds will be much lower in the future than they have been over the past 50 years:

    Many of today’s investors have lived during the “golden age” of investing and have grown accustomed to equities and bonds yielding a certain level of return and have made the assumption that past returns are indicative of future returns.