Our Fragile, Brittle Stock Market

The relentless melt-up in stocks offers ample evidence that the market is rock-solid and that any decline is an enormous opportunity to buy the dip. That this has worked splendidly for the past 13 years cannot be denied.

This doesn't necessarily guarantee the next 13 years will merely be an extension of the same trend. The market's sources of fragility and brittleness are well cloaked by low-volume melt-ups; these vulnerabilities only become visible in high-volume sell-offs such as 2020's brief mini-crash.

To understand the fragility at the heart of the market, we must return to the Global Financial Meltdown of 2008-09 and former Fed Chairman Alan Greenspan's explanation of why he and all the other experts failed to understand the market's vulnerabilities and thus failed to forecast the global crash.

Never Saw It Coming: Why the Financial Crisis Took Economists By Surprise (Dec. 2013 Foreign Affairs):

"The financial crisis that ensued represented an existential crisis for economic forecasting. The conventional method of predicting macroeconomic developments -- econometric modeling, the roots of which lie in the work of John Maynard Keynes -- had failed when it was needed most, much to the chagrin of economists. In the run-up to the crisis, the Federal Reserve Board's sophisticated forecasting system did not foresee the major risks to the global economy. Nor did the model developed by the International Monetary Fund."

In essence, Greenspan argued that the fancy models did not anticipate or capture human emotions in a financial panic. This is a remarkable confession, given the long study of panics and the wealth of research available on human emotions.

Greenspan then moved on to the real issue: liquidity--the bid to buy stocks--disappears:

"They (financial firms) failed to recognize that market liquidity is largely a function of the degree of investors' risk aversion, the most dominant animal spirit that drives financial markets. But when fear-induced market retrenchment set in, that liquidity disappeared overnight, as buyers pulled back. In fact, in many markets, at the height of the crisis of 2008, bids virtually disappeared."

1 2 3
View single page >> |

Disclosures: None.

How did you like this article? Let us know so we can better customize your reading experience.

Comments

Leave a comment to automatically be entered into our contest to win a free Echo Show.