Tag Archives: Stock market

Updates from Chicago Booth

Trade policy is upending markets—but not investment
By Steven J. Davis – Trade-policy concerns became a major source of US stock market volatility in 2018. For example, the S&P 500 fell 2.5 percent on March 22, 2018, reacting to news about just-announced US tariffs on tens of billions of dollars of Chinese imports. Four days later, the index rose 2.7 percent on news the United States and China had begun trade negotiations. Still, tariffs and tariff threats between the two countries ratcheted upward over the next several months.

This prominence marks a striking change, as demonstrated in my research with Northwestern’s Scott R. Baker, Northwestern PhD candidate Marco Sammon, and Stanford’s Nicholas Bloom. We took a systematic look at the role of trade-policy developments and other news in large daily stock market moves. We first identified every daily move of 2.5 percent or more, up or down, in the US stock market. By this criterion, there were 1,112 large daily moves from 1900 to the end of 2018.

For each large move, we read next-day news articles in the Wall Street Journal to classify perceptions of what moved the market. The WSJ attributed seven of 1,103 large moves from 1900 to 2017 mainly to news about trade policy. But in a remarkable turnabout, the newspaper attributed three of nine large moves in 2018 to trade-policy news. From a historical perspective, the prominent role of trade policy in recent US stock market swings is highly unusual.

The highly visible US–China dispute is only one of the heightened trade-policy concerns behind the pattern we chart. The US has also become enmeshed in trade-policy disputes with several other major trading partners since Donald Trump became president.

How much do these heightened concerns affect capital-investment expenditures by US businesses? Not as much as you might think. more>

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Updates from Chicago Booth

What causes stock market crashes, from Shanghai to Wall Street
By Michael Maiello – The Shanghai Stock Exchange reached a historic peak in June 2015, and then plunged, losing almost 40 percent of its value in a month. This crash of the world’s second-largest stock market evoked comparisons to the 1929 Wall Street collapse, and provided a laboratory for testing an enduring explanation of its causes.

It has long been theorized that the 1929 crash reflected “leverage-induced fire sales,” according to University of International Business and Economics’ Jiangze Bian, Chicago Booth’s Zhiguo He, Yale’s Kelly Shue, and Tsinghua University’s Hao Zhou. They acknowledge that the theory has been well-developed to explain how excessive leverage makes investors sell in emergency conditions, accelerating market crashes. But they suggest that, until now, the empirical research has been lacking—and the China crash finally offers empirical evidence.

The researchers analyzed account-level data for hundreds of thousands of investors in China’s stock market. Because leverage was introduced in mainland China only in 2010, Bian, He, Shue, and Zhou were able to examine the implications of leverage-limiting regulations imposed in this decade. During the first half of 2015, there were two sources of leverage for Chinese investors—regulated brokerage houses and nonregulated online lending platforms. The latter, along with other nonbank lenders such as trust companies, formed the shadow-banking industry in China. The researchers thus studied the effects of each type of borrowing. more>

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Rational Irrational Exuberance?

By Andrés Velasco – The timing was exquisitely ironic: equity markets peaked – and a week later began crashing – just as pundits left this year’s World Economic Forum meeting in Davos, where they concluded that the global economy was on a steady upswing. In the weeks since, experts have divided into two camps.

Some, including new US Federal Reserve Board chairman Jerome Powell, believe that economic fundamentals are strong, and that what stock markets experienced in early February was only a temporary hiccup.

Then there are those who believe that fundamentals are in fact weak, that the current upswing will prove unsustainable, and that investors should regard stock-market gyrations as a necessary wakeup call.

Both schools of thought share a focus on fundamentals, unlike a third – and, in my opinion, highly plausible – view: that the asset-price volatility we have been seeing has little or nothing to do with changes in fundamentals.

The human brain is wired to structure knowledge around narratives in which we can tell if and how A (and B and C) causes X. We tend to be uncomfortable with the notion that an economy’s fundamentals do not determine its asset prices, so we look for causal links between the two. But needing or wanting those links does not make them valid or true. more>

Is the next financial crisis looming

By Ross Barry -The strong performance of many share markets around the world has led many to speculate that another major correction may not be too far away. History has shown us, over the past 300 years or so, that major corrections have occurred every nine to 10 years, on average, albeit some have come closer on the heels of the one before, while others have been more than 20 years apart.

History has also shown us that financial manias and crashes are almost always an outworking of three things – an accumulation of large volumes of idle capital (savings), financial innovation and leverage. Most have also occurred following a strong, speculative surge in markets and a few years into a new phase of higher interest rates.

The less opportunities there are to deploy savings to create new wealth, the more they accumulate in safer stores of wealth. And the more wealth is stored rather than used creatively, the more the return on idle savings declines. The fact that yields on cash and bonds around the world are currently at, or below, zero per cent in real terms, tells us that there is a lot of storing going on right now.

We have seen this throughout history in the shadowy practice of “melting debt” in the 1860s, the proliferation of margin lending by Wall Street firms in the 1920s, the development of futures, options and “repo” markets in the late-1980s, and again with the mass production of highly leveraged CDOs built from sub-prime mortgages in the mid-2000s.

Too often, unfortunately, when productive risk-taking in an economy dries up, clever agents turn to new and resourceful ways to repackage riskier assets and promote them as something seemingly safer.

What makes investors succumb to the lure of such things is a whole study unto itself. more>

Updates from Chicago Booth

Lost money? Reinvest!
By Erik Kobayashi-Solomon – Investors sometimes play a psychological trick on themselves when they lose money, research suggests—and that mental accounting trick may help improve their investment performance.

According to Cary D. Frydman and David H. Solomon at the University of Southern California and Chicago Booth’s Samuel Hartzmark, investors who sell a losing investment often avoid the psychological pain by immediately reinvesting in another stock. By doing so, instead of thinking of the action as realizing a loss, they frame it as rolling capital into a related investment. The reference point used to compute gains and losses is linked to the amount paid for the original asset.

That mental accounting trick may help them avoid an often-made mistake. A key insight of behavioral finance is that investors, to avoid the pain of realizing a loss, fall prey to the disposition effect: they tend to be more likely to sell winners than losers. But the act of reinvesting makes investors more willing to sell a losing stock and realize a loss sooner. more>

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The Hidden Meaning of Dow 20000

By Paula Dwyer – Since Donald Trump won the U.S. presidential election, the Dow Jones Industrial Average has risen almost 9 percent, flirting with closing for the first time ever at the 20,000 mark. The year-end rally is the market’s way of saying it approves of the president-elect’s ideas.

As well it should. Trump’s tax-cutting, deregulating and deficit-spending policies are tailor-made to boost corporate profits.

Now would be a good moment to wave the yellow flag. This may not be such great news for the rest of the economy.

What’s happening is exactly what some economists had predicted over the summer: In Trump’s first two years as president, business-friendly policies would lower corporate costs, and stock investors would get a bigger share of the economic pie. more> https://goo.gl/YjeH34

Michael Dell Bought His Company Too Cheaply

By Matt Levine – Appraisal is a weird bit of corporate law, because it undermines the usual nice clean process of deciding how much a stock is worth by just seeing what someone will pay for it.

In 2012, with the “market not getting” Dell and valuing it at just $9.35 a share, Michael Dell rounded up some financing sources and offered to pay about $12 or so for it. Eventually. Michael Dell and his private-equity backers at Silver Lake ended up paying about $13.75 a share ($13.96 counting some dividends) in a $25 billion deal that they signed in February 2013 and closed in October of that year.

Then some shareholders sued in an appraisal lawsuit, arguing that the $13.75 was too low and that a Delaware court should award them more money.

On Tuesday (May 31) Delaware Vice Chancellor Travis Laster ruled on the remaining appraisal claims and found, in a 114-page opinion, that Dell was really worth $17.62 a share, so everyone who successfully sued — and managed to jump through the correct hoops — is entitled to an extra $3.87 a share, with interest.

To get there, first of all, Vice Chancellor Laster had to disregard the market price for the stock, which was $9.35 when the deal was first proposed, $13.42 when it was officially signed, and never closed above $14.51 afterward.

The market price didn’t reflect fair value, not because the market didn’t have the relevant information, but because it weighted it incorrectly. Analysts had a myopic “focus on short-term, quarter-by-quarter results,” and couldn’t understand the long-term value of the company’s plan. more> http://goo.gl/vISqXO

Tracing Oil’s Hypnosis of Stocks From Wealth Funds to Junk

By Dani Burger, Oliver Renick – Understanding why oil is casting such a spell is more than an academic inquiry.

The reason matters, given how big the moves have been. Almost $1.6 trillion has been erased from U.S. stocks in 2016. If oil is contributing, it’d be nice to know why.

Here are four theories on what’s underpinning the connection.

They range from a straight economic signal to speculation oil’s plunge threatens to lay low everything up to and including the financial system.

Theory: The world’s biggest investors are being forced to sell everything that isn’t nailed down to offset the hit they are taking on their crude holdings. After getting pummeled in commodity trading, investors may be stepping into stocks and unloading. more> http://goo.gl/C05DGw

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Market tailspin hastens the economic shock it fears

By Mike Dolan – History suggests governments and central banks would do well to sit up and take notice, but with policy coordination at its lowest ebb in decades, a coherent response is unlikely.

With almost $6 trillion wiped off the value of global stock markets since the start of the year and another 25 percent off already low oil prices, there is a real risk investor anxiety itself will be the catalyst for a world recession.

“When two players sit down at the board, they are unlikely to have a satisfactory game if one of them thinks they are playing checkers and the other thinks they are playing chess,” Jeffrey Frenkel [2] wrote.

By any measure, we are in historic territory. more> http://goo.gl/fnenki

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Be Scared of China’s Debt, Not Its Stocks

By Noah Smith – If a stock bubble and crash were China’s only problems, the danger might not be so great. Research shows that bubbles are less damaging to the real economy when they mostly involve equity rather than debt.

Debt crashes inflict harm on the financial system, creating major recessions that take years to repair.

Equity crashes, meanwhile, merely reduce paper wealth. A good example of an equity bubble that wasn’t very harmful was the late 1990s U.S. dot-com boom. When it ended, stock prices were devastated, but the crash led to only the mildest of recessions.

China probably also has a debt problem. more> http://goo.gl/tCn4xo

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