Thursday, July 23, 2009
Wenzel: Market Prices Reflect Information Except About Money Supply
Every now and again it's fun to disrupt the blogospherical equilibrium by picking a fight with your allies. Hence today I will point out my serious reservations with Robert Wenzel's analysis of stock prices and his preferred monetary aggregate, non-seasonally adjusted M2.
Back on June 12 Wenzel announced (CAPS in original):
Just to make sure that he is still sticking to this story, yesterday Wenzel wrote:
I have several problems with all of this. First and most serious: How can you possibly argue that stock prices respond to money supply numbers with a 3-month (or greater) lag? I understand if you want to argue that measured CPI responds only slowly to injections of new money; fair enough. But surely it shouldn't take forward-looking investors three months to digest the implications of a change in Fed policy. Imagine if oil prices crashed one day. Would anybody say, "It was because the Saudis cut production two months ago"?
Yes, there is certainly a connection between Fed policy and nominal stock prices, but it can't be backward-looking and with a lag (let alone a variable lag!). That is impossible to reconcile with any type of sensible expectations theory. I'm not claiming that the efficient markets hypothesis is correct; I'm just saying that it can't possibly take speculators months to react to unexpected changes in Fed policy.
But let's put aside all of the theoretical issues. In practice, how useful is Wenzel's approach? Mostly because of the huge upswing today, the S&P 500 right now is up more than 3% from when Wenzel first warned us (on June 12) that the market rally was kaput. That's more than a 20% annualized rate of appreciation, which isn't a bad return in the present environment.
Yes yes, of COURSE the stock market is bouncing around like crazy; for all I know it might fall 3% tomorrow. And just because it rose at 3% in less than two months, it doesn't mean it will continue to do so for the next year.
But my point is, if Wenzel's theory is driven by 3-month changes in (nsa) M2. This variable was almost perfectly flat from the week of March 23 to the week of July 6. If the market were much lower today than it was at some point in the interval, I am quite sure Wenzel would have pointed to that as vindication of his analysis.
This is the supreme problem with monetary theories that rely on "long and variable lags." They are non-falsifiable, because no matter what happens, you can always pore over the last two years of data and find some monetary trend to point to as "causing" whatever is happening today.
Of course, pure economic theory is a priori; Mises argued (and I agree with him--and so does Wenzel I believe) that you come to the table already armed with theories about how the economy works. It is precisely this antecedent framework that allows you to interpret the vast reams of data pouring in by the hour.
But on either count--theoretical or empirical--I don't see how looking at lagged changes in M2 explains stock movements.
A final note: I am sure that Wenzel is much more attuned to market movements than I am. If you had $1000 to entrust to either of our calls on market timing, you would do better to give it to Wenzel. What I am saying though is that when he steps back and tries to formalize why he thinks the market will do such-and-such, he is not accurately crystallizing his tacit knowledge. But because his theory is so open-ended, I don't think he even sees when it is being contradicted by actual events.
Back on June 12 Wenzel announced (CAPS in original):
MAJOR ALERT: Another Major Switch in Fed Policy?
After unprecedented money growth, in recent weeks I have hinted that Fed money growth was slowing. The latest data now show that money supply is now in a nosedive.
The whipsaws in Fed monetary policy under Fed chairman Ben Bernanke are unprecedented.
In early 2008, money supply (M2 not seasonally-adjusted) grew at rate of around 12%. During the summer of 2008, Bernanke reversed engines and completely slammed on the breaks and slowed money supply growth to 1.2% annualized. This last money slow down is what I believe intensified the downturn.
In late September 2008, in panic, Bernanke opened the money spigot, again, For approximately 6 months we had money growth of near 15% on an annualized basis. An unprecedented amount of Fed money growth. This is what I believe is fueling the current rebound in stocks and commodities.
However, it appears that Bernanke may now be reversing policy, again. The latest numbers from the Fed show that over the last three months the money supply has actually declined. On March 9, 2009 M2 non-seasonally adjusted stood at 8363.7 billion. Yesterday, the Fed reported that as of June 1, 2009 the money supply stood at 8335.1 billion. This is an annualized decline of of 1.4% in the money supply.
Needless to say, this stock market climb is pretty much over, if Bernanke keeps this money shrinkage act up.
Just to make sure that he is still sticking to this story, yesterday Wenzel wrote:
[A]s I have warned many times, the Fed is not printing any money at the current time. Couple this with the fact that August begins the start of seasonal down trend in the market and we [could] be in for a lot of trouble.
...
If Bernanke keeps up his no money printing stance, there is a huge market break coming. Don't be sucked in by any short term rallies. The money isn't there to support them long term.
I have several problems with all of this. First and most serious: How can you possibly argue that stock prices respond to money supply numbers with a 3-month (or greater) lag? I understand if you want to argue that measured CPI responds only slowly to injections of new money; fair enough. But surely it shouldn't take forward-looking investors three months to digest the implications of a change in Fed policy. Imagine if oil prices crashed one day. Would anybody say, "It was because the Saudis cut production two months ago"?
Yes, there is certainly a connection between Fed policy and nominal stock prices, but it can't be backward-looking and with a lag (let alone a variable lag!). That is impossible to reconcile with any type of sensible expectations theory. I'm not claiming that the efficient markets hypothesis is correct; I'm just saying that it can't possibly take speculators months to react to unexpected changes in Fed policy.
But let's put aside all of the theoretical issues. In practice, how useful is Wenzel's approach? Mostly because of the huge upswing today, the S&P 500 right now is up more than 3% from when Wenzel first warned us (on June 12) that the market rally was kaput. That's more than a 20% annualized rate of appreciation, which isn't a bad return in the present environment.
Yes yes, of COURSE the stock market is bouncing around like crazy; for all I know it might fall 3% tomorrow. And just because it rose at 3% in less than two months, it doesn't mean it will continue to do so for the next year.
But my point is, if Wenzel's theory is driven by 3-month changes in (nsa) M2. This variable was almost perfectly flat from the week of March 23 to the week of July 6. If the market were much lower today than it was at some point in the interval, I am quite sure Wenzel would have pointed to that as vindication of his analysis.
This is the supreme problem with monetary theories that rely on "long and variable lags." They are non-falsifiable, because no matter what happens, you can always pore over the last two years of data and find some monetary trend to point to as "causing" whatever is happening today.
Of course, pure economic theory is a priori; Mises argued (and I agree with him--and so does Wenzel I believe) that you come to the table already armed with theories about how the economy works. It is precisely this antecedent framework that allows you to interpret the vast reams of data pouring in by the hour.
But on either count--theoretical or empirical--I don't see how looking at lagged changes in M2 explains stock movements.
A final note: I am sure that Wenzel is much more attuned to market movements than I am. If you had $1000 to entrust to either of our calls on market timing, you would do better to give it to Wenzel. What I am saying though is that when he steps back and tries to formalize why he thinks the market will do such-and-such, he is not accurately crystallizing his tacit knowledge. But because his theory is so open-ended, I don't think he even sees when it is being contradicted by actual events.
Comments:
Bob,
I've been concerned about this as well. However, another interpretation of what you're arguing might be to say "Since the market is forward-looking, and it bottomed in March, right around the time M2 nsa slowed down... maybe the market saw that months ago and that's why it turned down... now, the market is predicting major inflation"
After all, there are zero fundamental reasons for the markets to be going higher, and very few technical reasons as well (just because the market may have initially overshot on the downside on the last leg down does not mean a 30, 40, 50% rally, etc., is somehow not justified on the upside).
I have a friend who keeps asking me why, now that he understands the basics of economics and Austrian theory, he should continue to read on. He says it is only valuable if it can give you better ideas about investing. I agree that there is merit to the idea that if this theory we know doesn't help us invest, it doesn't do a whole lot else for us (since we're not politicians and we understand that politics isn't the answer anyway). And you'll have to excuse my criticism a bit because I'm not saying it has NO utility-- I've told my friend and others that, if anything, econ helps you learn how to think more accurately and gives you a different perspective on a lot of other areas of life.
I wonder if Austrianism is non-falsifiable? After all, if this market just keeps rallying despite our belief that government intervention and money printing destroy economies, we'll likely hold onto our beliefs regardless... then, decades later when things finally crash, we'll say "Seeeeee! Seeee! We told you!" as we're doing right now, after being "disproved" for most of the earlier part of this decade.
On the other hand, I think Wenzel could argue, and others have (Gary North) and I certainly subscribe to this... MARKET prices reflect all kinds of information. But if you're operating in a hampered or even manipulated market, then that's another story.
Consider-- we have no idea where all the TARP and Fed money is going or how it's getting there. We have no idea who is doing whose bidding in the marketplace. It's possible Goldman and other broker-dealers, as well as the Fed itself, could be using TARP money to pump up the markets far beyond where they reasonably, and fundamentally ought to be.
Would you be as critical of Wenzel if unemployment was 50%, money supply had plummeted and the stock market was touching new highs, as if by magic?
I've been concerned about this as well. However, another interpretation of what you're arguing might be to say "Since the market is forward-looking, and it bottomed in March, right around the time M2 nsa slowed down... maybe the market saw that months ago and that's why it turned down... now, the market is predicting major inflation"
After all, there are zero fundamental reasons for the markets to be going higher, and very few technical reasons as well (just because the market may have initially overshot on the downside on the last leg down does not mean a 30, 40, 50% rally, etc., is somehow not justified on the upside).
I have a friend who keeps asking me why, now that he understands the basics of economics and Austrian theory, he should continue to read on. He says it is only valuable if it can give you better ideas about investing. I agree that there is merit to the idea that if this theory we know doesn't help us invest, it doesn't do a whole lot else for us (since we're not politicians and we understand that politics isn't the answer anyway). And you'll have to excuse my criticism a bit because I'm not saying it has NO utility-- I've told my friend and others that, if anything, econ helps you learn how to think more accurately and gives you a different perspective on a lot of other areas of life.
I wonder if Austrianism is non-falsifiable? After all, if this market just keeps rallying despite our belief that government intervention and money printing destroy economies, we'll likely hold onto our beliefs regardless... then, decades later when things finally crash, we'll say "Seeeeee! Seeee! We told you!" as we're doing right now, after being "disproved" for most of the earlier part of this decade.
On the other hand, I think Wenzel could argue, and others have (Gary North) and I certainly subscribe to this... MARKET prices reflect all kinds of information. But if you're operating in a hampered or even manipulated market, then that's another story.
Consider-- we have no idea where all the TARP and Fed money is going or how it's getting there. We have no idea who is doing whose bidding in the marketplace. It's possible Goldman and other broker-dealers, as well as the Fed itself, could be using TARP money to pump up the markets far beyond where they reasonably, and fundamentally ought to be.
Would you be as critical of Wenzel if unemployment was 50%, money supply had plummeted and the stock market was touching new highs, as if by magic?
Taylor wrote:
Would you be as critical of Wenzel if unemployment was 50%, money supply had plummeted and the stock market was touching new highs, as if by magic?
I'm not following your example. If money supply had plummeted and stock markets hit new highs, then Wenzel would obviously be wrong.
And in my bet with Wenzel, I said unemployment at the end of 2009 would be higher than at the beginning, while he said the opposite. So unemployment of 50% would be another reason for him to be wrong.
(I think that was one of the planks of our bet; I may be wrong on the exact timing of the unemployment numbers, but I thought it was going to go up and he thought not.)
Would you be as critical of Wenzel if unemployment was 50%, money supply had plummeted and the stock market was touching new highs, as if by magic?
I'm not following your example. If money supply had plummeted and stock markets hit new highs, then Wenzel would obviously be wrong.
And in my bet with Wenzel, I said unemployment at the end of 2009 would be higher than at the beginning, while he said the opposite. So unemployment of 50% would be another reason for him to be wrong.
(I think that was one of the planks of our bet; I may be wrong on the exact timing of the unemployment numbers, but I thought it was going to go up and he thought not.)
Bob,
Sorry, to be clear the point of my example was to see if you'd have any skepticism towards a stock market hitting new highs in the face of 50% unemployment. It was my understanding that because the market has not cratered, and Wenzel said it would because of money supply dropping, he is wrong. I countered that the fundamentals don't support this action and that the market is behaving, dare I say it, "irrationally." So the example I gave you had an extreme level of unemployment that should signify such deteriorated fundamentals that there would be no reason for the market to rally higher, and yet it was doing so. Coincidentally, Wenzel's favorite indicator would also be saying "this isn't right" to the stock market rally.
I was wondering if, in a context like that, you'd be less prone to concluding Wenzel is wrong, and more prone to wondering if the market is wrong/if it's being manipulated somehow.
But maybe I don't get what everyone is talking about here.
Sorry, to be clear the point of my example was to see if you'd have any skepticism towards a stock market hitting new highs in the face of 50% unemployment. It was my understanding that because the market has not cratered, and Wenzel said it would because of money supply dropping, he is wrong. I countered that the fundamentals don't support this action and that the market is behaving, dare I say it, "irrationally." So the example I gave you had an extreme level of unemployment that should signify such deteriorated fundamentals that there would be no reason for the market to rally higher, and yet it was doing so. Coincidentally, Wenzel's favorite indicator would also be saying "this isn't right" to the stock market rally.
I was wondering if, in a context like that, you'd be less prone to concluding Wenzel is wrong, and more prone to wondering if the market is wrong/if it's being manipulated somehow.
But maybe I don't get what everyone is talking about here.
@Taylor
You write:I have a friend who keeps asking me why, now that he understands the basics of economics and Austrian theory, he should continue to read on. He says it is only valuable if it can give you better ideas about investing. I agree that there is merit to the idea that if this theory we know doesn't help us invest, it doesn't do a whole lot else for us
Do you seriously think there was no value in the warnings that Schiff, Ebeling, North and me gave about the real estate bubble?
You write:I have a friend who keeps asking me why, now that he understands the basics of economics and Austrian theory, he should continue to read on. He says it is only valuable if it can give you better ideas about investing. I agree that there is merit to the idea that if this theory we know doesn't help us invest, it doesn't do a whole lot else for us
Do you seriously think there was no value in the warnings that Schiff, Ebeling, North and me gave about the real estate bubble?
Wenzel,
I'm on a roll today as far as miscommunicating goes.
I think that those type of warnings are precisely the value my friend expects to get from studying sound economics.
I guess what he's after, which economics won't give him, is an answer to the question "where should I put my money." I've hoped that studying more will give me the same answer. But, aside from explaining what's tenable and what isn't economically-speaking, economics will not offer investment advice.
It may reveal to you that there is a housing bubble, but it will not tell you where to put your money instead of in houses.
Is that accurate in your mind?
I'm on a roll today as far as miscommunicating goes.
I think that those type of warnings are precisely the value my friend expects to get from studying sound economics.
I guess what he's after, which economics won't give him, is an answer to the question "where should I put my money." I've hoped that studying more will give me the same answer. But, aside from explaining what's tenable and what isn't economically-speaking, economics will not offer investment advice.
It may reveal to you that there is a housing bubble, but it will not tell you where to put your money instead of in houses.
Is that accurate in your mind?
Well, you could short housing stocks nd banks. And, if the Fed is printing like crazy, you it certainly makes sense based on Austrian theory to buy gold.
Usually, I see two or three good "Austrian" trdaes out there.
Usually, I see two or three good "Austrian" trdaes out there.
Wenzel,
But how did Austrian theory tell you to invest in the period of about 1981-2001, when the govt was printing, everyone was participating in bailouts and faulty economics and making money hand over fist?
We might be in agreement here and I am arguing a non-point because I myself do not recognize the "two or three Austrian trades" out there right now. One reason is we can't seem to figure out if the immediate term picture is inflation or deflation, so it's hard to feel good about gold in that time horizon (forget buying it for the long haul, which I agree is sound). And you could say "short banks and housing stocks" but you're getting killed right now if you're doing that, and you likely will for some time still, as this market continues to behave in magic ways despite the indicators like M2 nsa you've pointed to.
But how did Austrian theory tell you to invest in the period of about 1981-2001, when the govt was printing, everyone was participating in bailouts and faulty economics and making money hand over fist?
We might be in agreement here and I am arguing a non-point because I myself do not recognize the "two or three Austrian trades" out there right now. One reason is we can't seem to figure out if the immediate term picture is inflation or deflation, so it's hard to feel good about gold in that time horizon (forget buying it for the long haul, which I agree is sound). And you could say "short banks and housing stocks" but you're getting killed right now if you're doing that, and you likely will for some time still, as this market continues to behave in magic ways despite the indicators like M2 nsa you've pointed to.
Taylor
There are many successful investors/money managers that have never heard of Austrian economics. In fact many are either fundamentalists, analyzing industries and companies for profitability or technical analysts simply following the price and volume movements of specific assets. Neither type uses much economic theory.
How many professional economists have also been really successful investors? You could count them on one hand.
However, Victor Sperandeo claimed to use Austrian theory in his very successful career and he wrote two books about it. George Soros claims to have developed his own economic theory called "reflexitivity." I don't find it very useful but he has been incredibly successful. Warren Buffet seems keynesian in his public statements but agnostic in his fund management. His mentor Ben Graham used 287 pages in his book titled "The Intelligent Investor" (1973)to write about inflation, market history, portfolio policy, financial analysis, and other tools to be successful. And in a postcript on page 289 he revealed the real secret to his investment success (its better if you read it yourself).
To be successful, to find a methodology that helps you to generate positive gains in your portfolio requires that you understand your own psychology. This will enable you to find a theory that speaks to you. That helps you understand the world and will inform your investment decisions.
There are many successful investors/money managers that have never heard of Austrian economics. In fact many are either fundamentalists, analyzing industries and companies for profitability or technical analysts simply following the price and volume movements of specific assets. Neither type uses much economic theory.
How many professional economists have also been really successful investors? You could count them on one hand.
However, Victor Sperandeo claimed to use Austrian theory in his very successful career and he wrote two books about it. George Soros claims to have developed his own economic theory called "reflexitivity." I don't find it very useful but he has been incredibly successful. Warren Buffet seems keynesian in his public statements but agnostic in his fund management. His mentor Ben Graham used 287 pages in his book titled "The Intelligent Investor" (1973)to write about inflation, market history, portfolio policy, financial analysis, and other tools to be successful. And in a postcript on page 289 he revealed the real secret to his investment success (its better if you read it yourself).
To be successful, to find a methodology that helps you to generate positive gains in your portfolio requires that you understand your own psychology. This will enable you to find a theory that speaks to you. That helps you understand the world and will inform your investment decisions.
@Taylor
I didn't say short banks or housing, now. Although they probbaly should go down. i only take positions, generally, when a move has gone against the trend I forsse for sometime (i'm talking years). The ideal time to have shorted bonds was before the first break. That's why I think shorting bonds is the best play, now.
As far as the 1981 - 2001 period, there were all sorts of opportunities, shorting gold for one. Going long the stock market after Volcker changed policy. Buying Manhattan real estate by buying a stock called Alexander's at $6.00. The all time high o the stock was $420.00. Shorting the Dow in 1987. Going lomg bonds when they paid well over 10%.
The plays are out there. Besides the short bond trade, there are currently two other trades that I consider Austrian in nature. I have reserved comment on those two for all but my clients. We are still accumulating, and are not yet inviting the world into the trades--nor do we have any plans to make such an invitation in the future.
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I didn't say short banks or housing, now. Although they probbaly should go down. i only take positions, generally, when a move has gone against the trend I forsse for sometime (i'm talking years). The ideal time to have shorted bonds was before the first break. That's why I think shorting bonds is the best play, now.
As far as the 1981 - 2001 period, there were all sorts of opportunities, shorting gold for one. Going long the stock market after Volcker changed policy. Buying Manhattan real estate by buying a stock called Alexander's at $6.00. The all time high o the stock was $420.00. Shorting the Dow in 1987. Going lomg bonds when they paid well over 10%.
The plays are out there. Besides the short bond trade, there are currently two other trades that I consider Austrian in nature. I have reserved comment on those two for all but my clients. We are still accumulating, and are not yet inviting the world into the trades--nor do we have any plans to make such an invitation in the future.
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