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Why do stock markets bubble & collapse? ... > One afternoon my mom and I found an envelope in the mail with the Nielsen consumer confidence survey and two dol

Why do stock markets bubble & collapse? ... > One afternoon my mom and I found an envelope in the mail with the Nielsen consumer confidence survey and two dollar bills enclosed. The cash was enough incentive for my mom to start filling it out, ticking a box that indicated the business environment in our Iowa town was as good as it was before the pandemic. > “Really?” I asked. “You think so?” > Her rationale was simple—more optimistic answers would help bolster the market. “I want stocks to go up,” she responded. --- NB. markets are not faith-based. They are evidence-based. The trader believes, eg., IF P(stock-increases | evidence) > risk THEN buy You create bubbles by believing, as all propagandists do, that reality doesn't exist. That belief is evidence. That works only until people re-evaluate their evidence. As soon as you look at, eg., actual productivity, the whole thing collapses.

deleted 6y ago
[deleted]
BatFastard 6y ago
>markets are not faith-based. They are evidence-based. Which is why we are seeing close to record highs in the middle of the worst pandemic in 100 years? Markets are irrational as far as I can see.
- mjburgess 6y ago
  The markets always track the future. At the moment, the market expects a boom. (It is probably incorrect; it might not be). That expectation, however, is being exaggerated by other people who likewise expect it. Sure. But we shouldn't characterise the market as irrationally faith-based, if it were, it would never go bust. It doesn't go bust because, for some random reason, people loose faith. Rather, their beliefs are revised with updated evidence, which propagates thru the market. This "correction towards reality" is always at work, but people attend to the evidence at different rates: when the whole market looks, then you go bust. There is a deeply tyrannical and propagandistic undercurrent to the view that human action is simply a matter of our "faith about the world", and not evidence. It encourages people to act as-if false things were true; and requires others to do so; to cause great catastrophes precisely because the false things arent true.
  - pjc50 6y ago
    Not a believer in Keynes "animal spirits", then? > encourages people to act as-if false things were true Your last paragraph, which I broadly agree with, is at odds with the rest of it, which is classic naive efficient-market-hypothesis stuff. It's complicated to discuss what "evidence" means for events in the future, because it rapidly heads into deep waters of philosophy, but like the 538 election prediction the best we can do about the future is have a probability distribution of outcomes. And as a result there are three big effects: one is low-probability events turning out to actually happen sometimes ("black swan"), another is events you wanted to be uncorrelated turn out to be correlated (which blew up mortgage "tranches"), and the third is that other people's action is market-driving information even if it's irrational; panic selling causes more panic selling, bank runs are real, etc.
    - darawk 6y ago
      > It's complicated to discuss what "evidence" means for events in the future, because it rapidly heads into deep waters of philosophy, but like the 538 election prediction the best we can do about the future is have a probability distribution of outcomes. And as a result there are three big effects: one is low-probability events turning out to actually happen sometimes ("black swan"), another is events you wanted to be uncorrelated turn out to be correlated (which blew up mortgage "tranches"), and the third is that other people's action is market-driving information even if it's irrational; panic selling causes more panic selling, bank runs are real, etc. Markets make point estimates. Derivatives markets make distributional estimates. The information is all there, and if you disagree with it, you can make bets to that effect. But most people won't do that, because they don't actually believe that the market is inefficient. There's very good justification for the present stock market rally, especially if you pay attention to the market's internal structure. The pandemic is driving consolidation, and changing habits. Changes that primarily benefit high scale businesses. The disconnect between the state of the economy and the state of the S&P 500 is driven primarily by this distinction. The market is correct to price in a boom. You are also correct to fear a recession. These things are only mutually exclusive if you mistake the stock market for the broader economy. It's also true that there are major tail risks present. The market is not ignoring them. The market is saying that the expected value, inclusive of those tail risks, is positive. You can see the market pricing those tail risks in if you look at the implied volatility surface of options right now. It's there. It's really important to understand that the fact that a price turns out to be wrong does not make markets inefficient, or even incorrect. Gamblers making statistically correct bets are wrong all the time. That's just the way uncertainty works in the world. There are people arbitraging uncertainty at all points of the distribution, from the tail on up. It's true that markets are less efficient around low probability events. But it's also true that they quickly learn from their mistakes
- dasudasu 6y ago
  Consider that trillions in new money were created out of thin air and that bond yields crashed. The discount rate for equities just got massively re-evaluated. Also, only select sectors that were already overweighted by indices are up significantly from pre-pandemic levels.
  - iaw 6y ago
    Any thoughts on whether this is actually going to represent a wave of inflation?
    - dasudasu 6y ago
      Asset inflation, probably, which is what many people agreed happened in the last decade.
athriren 6y ago
in a strict sense, all markets guaranteed by the government of a single state are faith-based, given the market-as-it-exists is dependent on the state for enforcement of laws and as a guarantor of some basic standards allowing for the market to function.
- pmiller2 6y ago
  Exactly. Currency markets are kind of the ultimate in this sort of “faith-based” market.
- mjburgess 6y ago
  well the institution of the market relies upon the institution of the gov, and is "based" in this sense not on "faith" -- but on the monopoly of violence of the state to enforce the laws which enable market activity the sense of "based" relevant to market behaviour, though, is whether buy/sell/etc. activity (ie., trader actions) is based on faith or not -- and it is largely, not each action is the result of an evidenced-belief, and as the quality of the evidence improves, and spreads, the market changes. It is (inefficiently) responsive to evidence, rather than based in faith.
  - athriren 6y ago
    the faith every agent in the market demonstrates in the market is that the market itself will not collapse as a result of the behavior (or sudden non-existence) of the state. faith and “evidence based belief” are perhaps more entangled in my head than yours, though. my only point is that at some point each actor comes to the conclusion that they have enough information, that this information is predictive, and that the future is comprehensible. it is impossible to know future outcomes, so on some level every best-judgment action people take in a market demonstrates this baseline “faith”.
nathias 6y ago
Based on evidence would mean that there is an established transparent peer-reviewed process of buying stocks, based on belief means that people decide what evidence to believe for themselves. Guess which one markets are.
jiofih 6y ago
> markets are not faith-based. They are evidence-based. That is only true on the surface. The “evidence” that guides the majority of trades is made up of signals created by all kinds of irrational behaviour. Something that is appraised by its future value, by definition won’t ever be purely evidence based.
rjkennedy98 6y ago
This sounds very rational but it is mostly wrong. Stock market like many other assets are driven mostly by credit cycles. Bubbles are created by natural credit cycles. The vast majority of money in the USA isn't hard cash, its credit. And low interest rates and other things can rapidly expand the amount of credit. We are in a period of extremely low interest rates and quantitative easing as well as deficit spending by the government. Hedge funds like Ray Dalio's track credit and do it to a precision that is widely regard as even better than the federal reserve. https://www.youtube.com/watch?v=PHe0bXAIuk0 https://www.youtube.com/watch?v=PHe0bXAIuk0
- darawk 6y ago
  Credit cycles are orthogonal to the issue of market efficiency. Credit cycles do not prove that the market is irrational, quite the contrary. The problem with credit cycles is that we are not yet good enough at forecasting exactly when they will end, which is why the market rewards people like Dalio who do the research to try to work that out, but even they are often wrong.
munificent 6y ago
I think a better mental model is to realize markets are a Keynesian beauty contest [1]. You don't make money in a market by correctly observing the ground truth, you do so by correctly predicting the behavior of other market participants. [1]: https://en.wikipedia.org/wiki/Keynesian_beauty_contest https://en.wikipedia.org/wiki/Keynesian_beauty_contest
okprod 6y ago
You can talk semantics all you want, but at the end of the day, look at your average Robin Hood trader on StockTwits and we can see exactly what the market is.
marketgod 6y ago
It's late Autumn and the Indians on a remote reservation in North Dakota have asked their new Chief if the coming winter is going to be cold or mild. Since he was a modern-day Chief he'd never actually been taught the old indian ways or their secrets, so when he looked at the sky, he just couldn't tell what the winter weather was going to be like. Nevertheless, in order not to disappoint the tribe and to be on the safe side, he told them that the winter was indeed going to be cold and that they should collect firewood and be prepared. However, being a practical leader, after several days, he got an idea. He went to the phone booth, called the National Weather Service and asked, “Is the coming winter going to be cold?” “It looks like this winter is going to be quite cold" they responded. So the Chief went back to his people and told them to collect even more firewood in order to be better prepared. A week later, he called the National Weather Service again, “Does it still look like it is going to be a very cold winter?” “Yes”, replied the man at National Weather Service this time, even more certain,“it's going to be a very, very cold winter.” So the Chief went back to his people once again and ordered them to collect every scrap of firewood they could lay their hands on. Two weeks later, worried about the mountains of wood and the hard work the tribe was putting in collecting it, the chief called the National Weather Service just to be absolutely sure."Are you definitely sure that the winter is going to be very cold?” “Absolutely”, the weatherman said, “It's looking more and more like it's going to be one of the coldest winters on record.” “But how can you be so certain?” the chief asked. "Well, for a start" the weatherman replied, “the Indians are collecting a shedload of firewood.”
- nicbou 6y ago
  This is the sort of comment I come here for

deleted 6y ago

[deleted]

BatFastard 6y ago

>markets are not faith-based. They are evidence-based. Which is why we are seeing close to record highs in the middle of the worst pandemic in 100 years? Markets are irrational as far as I can see.

mjburgess 6y ago
The markets always track the future. At the moment, the market expects a boom. (It is probably incorrect; it might not be). That expectation, however, is being exaggerated by other people who likewise expect it. Sure. But we shouldn't characterise the market as irrationally faith-based, if it were, it would never go bust. It doesn't go bust because, for some random reason, people loose faith. Rather, their beliefs are revised with updated evidence, which propagates thru the market. This "correction towards reality" is always at work, but people attend to the evidence at different rates: when the whole market looks, then you go bust. There is a deeply tyrannical and propagandistic undercurrent to the view that human action is simply a matter of our "faith about the world", and not evidence. It encourages people to act as-if false things were true; and requires others to do so; to cause great catastrophes precisely because the false things arent true.
- pjc50 6y ago
  Not a believer in Keynes "animal spirits", then? > encourages people to act as-if false things were true Your last paragraph, which I broadly agree with, is at odds with the rest of it, which is classic naive efficient-market-hypothesis stuff. It's complicated to discuss what "evidence" means for events in the future, because it rapidly heads into deep waters of philosophy, but like the 538 election prediction the best we can do about the future is have a probability distribution of outcomes. And as a result there are three big effects: one is low-probability events turning out to actually happen sometimes ("black swan"), another is events you wanted to be uncorrelated turn out to be correlated (which blew up mortgage "tranches"), and the third is that other people's action is market-driving information even if it's irrational; panic selling causes more panic selling, bank runs are real, etc.
  - darawk 6y ago
    > It's complicated to discuss what "evidence" means for events in the future, because it rapidly heads into deep waters of philosophy, but like the 538 election prediction the best we can do about the future is have a probability distribution of outcomes. And as a result there are three big effects: one is low-probability events turning out to actually happen sometimes ("black swan"), another is events you wanted to be uncorrelated turn out to be correlated (which blew up mortgage "tranches"), and the third is that other people's action is market-driving information even if it's irrational; panic selling causes more panic selling, bank runs are real, etc. Markets make point estimates. Derivatives markets make distributional estimates. The information is all there, and if you disagree with it, you can make bets to that effect. But most people won't do that, because they don't actually believe that the market is inefficient. There's very good justification for the present stock market rally, especially if you pay attention to the market's internal structure. The pandemic is driving consolidation, and changing habits. Changes that primarily benefit high scale businesses. The disconnect between the state of the economy and the state of the S&P 500 is driven primarily by this distinction. The market is correct to price in a boom. You are also correct to fear a recession. These things are only mutually exclusive if you mistake the stock market for the broader economy. It's also true that there are major tail risks present. The market is not ignoring them. The market is saying that the expected value, inclusive of those tail risks, is positive. You can see the market pricing those tail risks in if you look at the implied volatility surface of options right now. It's there. It's really important to understand that the fact that a price turns out to be wrong does not make markets inefficient, or even incorrect. Gamblers making statistically correct bets are wrong all the time. That's just the way uncertainty works in the world. There are people arbitraging uncertainty at all points of the distribution, from the tail on up. It's true that markets are less efficient around low probability events. But it's also true that they quickly learn from their mistakes
dasudasu 6y ago
Consider that trillions in new money were created out of thin air and that bond yields crashed. The discount rate for equities just got massively re-evaluated. Also, only select sectors that were already overweighted by indices are up significantly from pre-pandemic levels.
- iaw 6y ago
  Any thoughts on whether this is actually going to represent a wave of inflation?
  - dasudasu 6y ago
    Asset inflation, probably, which is what many people agreed happened in the last decade.

athriren 6y ago

in a strict sense, all markets guaranteed by the government of a single state are faith-based, given the market-as-it-exists is dependent on the state for enforcement of laws and as a guarantor of some basic standards allowing for the market to function.

pmiller2 6y ago
Exactly. Currency markets are kind of the ultimate in this sort of “faith-based” market.
mjburgess 6y ago
well the institution of the market relies upon the institution of the gov, and is "based" in this sense not on "faith" -- but on the monopoly of violence of the state to enforce the laws which enable market activity the sense of "based" relevant to market behaviour, though, is whether buy/sell/etc. activity (ie., trader actions) is based on faith or not -- and it is largely, not each action is the result of an evidenced-belief, and as the quality of the evidence improves, and spreads, the market changes. It is (inefficiently) responsive to evidence, rather than based in faith.
- athriren 6y ago
  the faith every agent in the market demonstrates in the market is that the market itself will not collapse as a result of the behavior (or sudden non-existence) of the state. faith and “evidence based belief” are perhaps more entangled in my head than yours, though. my only point is that at some point each actor comes to the conclusion that they have enough information, that this information is predictive, and that the future is comprehensible. it is impossible to know future outcomes, so on some level every best-judgment action people take in a market demonstrates this baseline “faith”.

nathias 6y ago

Based on evidence would mean that there is an established transparent peer-reviewed process of buying stocks, based on belief means that people decide what evidence to believe for themselves. Guess which one markets are.

jiofih 6y ago

> markets are not faith-based. They are evidence-based. That is only true on the surface. The “evidence” that guides the majority of trades is made up of signals created by all kinds of irrational behaviour. Something that is appraised by its future value, by definition won’t ever be purely evidence based.

rjkennedy98 6y ago

This sounds very rational but it is mostly wrong. Stock market like many other assets are driven mostly by credit cycles. Bubbles are created by natural credit cycles. The vast majority of money in the USA isn't hard cash, its credit. And low interest rates and other things can rapidly expand the amount of credit. We are in a period of extremely low interest rates and quantitative easing as well as deficit spending by the government. Hedge funds like Ray Dalio's track credit and do it to a precision that is widely regard as even better than the federal reserve. https://www.youtube.com/watch?v=PHe0bXAIuk0 https://www.youtube.com/watch?v=PHe0bXAIuk0

darawk 6y ago
Credit cycles are orthogonal to the issue of market efficiency. Credit cycles do not prove that the market is irrational, quite the contrary. The problem with credit cycles is that we are not yet good enough at forecasting exactly when they will end, which is why the market rewards people like Dalio who do the research to try to work that out, but even they are often wrong.

munificent 6y ago

I think a better mental model is to realize markets are a Keynesian beauty contest [1]. You don't make money in a market by correctly observing the ground truth, you do so by correctly predicting the behavior of other market participants. [1]: https://en.wikipedia.org/wiki/Keynesian_beauty_contest https://en.wikipedia.org/wiki/Keynesian_beauty_contest

okprod 6y ago

You can talk semantics all you want, but at the end of the day, look at your average Robin Hood trader on StockTwits and we can see exactly what the market is.

marketgod 6y ago

It's late Autumn and the Indians on a remote reservation in North Dakota have asked their new Chief if the coming winter is going to be cold or mild. Since he was a modern-day Chief he'd never actually been taught the old indian ways or their secrets, so when he looked at the sky, he just couldn't tell what the winter weather was going to be like. Nevertheless, in order not to disappoint the tribe and to be on the safe side, he told them that the winter was indeed going to be cold and that they should collect firewood and be prepared. However, being a practical leader, after several days, he got an idea. He went to the phone booth, called the National Weather Service and asked, “Is the coming winter going to be cold?” “It looks like this winter is going to be quite cold" they responded. So the Chief went back to his people and told them to collect even more firewood in order to be better prepared. A week later, he called the National Weather Service again, “Does it still look like it is going to be a very cold winter?” “Yes”, replied the man at National Weather Service this time, even more certain,“it's going to be a very, very cold winter.” So the Chief went back to his people once again and ordered them to collect every scrap of firewood they could lay their hands on. Two weeks later, worried about the mountains of wood and the hard work the tribe was putting in collecting it, the chief called the National Weather Service just to be absolutely sure."Are you definitely sure that the winter is going to be very cold?” “Absolutely”, the weatherman said, “It's looking more and more like it's going to be one of the coldest winters on record.” “But how can you be so certain?” the chief asked. "Well, for a start" the weatherman replied, “the Indians are collecting a shedload of firewood.”

nicbou 6y ago
This is the sort of comment I come here for