Stock price volatility, by Harold Black, PhD

Harold Black, PhDBlog

I am no expert on the stock market. For that you need to read my colleague David Moon. However, I do have an opinion as to why the stock market has increased in volatility. Last month saw dramatic swings in the market. In one week, the markets swung over 1,000 points daily and changed directions over 50 times. By the end of that week the markets ended up. The experts said that during the week, the market entered “correction territory” intimating that stocks were over-valued which past Fed chairman Allen Greenspan referred to as “irrational exuberance”. No better cases for irrationality are Tesla stock and the price of Bitcoin. Tesla has a higher market valuation than Ford or General Motors despite never having made a profit and little prospect of profitability in the future. Bitcoin’s price last year increased by almost over 3,000%. Both Tesla and Bitcoin are now in what I call the “greater fool territory”. That is, one only buys at these prices not because of future returns from holding the asset, but because there is a greater fool than the buyer who will be willing to pay more for what is essentially a cult asset.

The question is why the return to volatility in the markets? One reason is the ending of the monetary policy direction of the Fed under Bernanke and Yellen. The bond purchasing policies of the Fed drove down bond yields and caused investors to seek higher returns – and higher risks – elsewhere, namely the stock market driving stock prices up. Stock prices since the presidential election also increased due to the prospect of less onerous regulation and the lowering of the corporate income tax. These factors along with rising consumer sentiment have led to forecasts of increased corporate profitability causing a rise in stock prices. In addition, the change in the Fed policy of ending bond buying means that bond prices will also rise prompting investors to diversify their portfolios away from higher risk stocks by adding bonds. This increased bond buying will pull the price of stocks downward. Consequently, the market is being pulled in two directions at once and is adjusting to the change in the Fed policy. The only reason the Fed continued buying bonds after 2009 was to aid and abet the $9 trillion growth in US deficits during the Obama years by keeping the interest on US debt low. Now with the new deficit-be-damned budget just enacted, coupled with the Fed’s decreased bond buying, the deficit will increase even further as higher interest payments are factored in. Thus, when you combine the increased growth, the increased deficit, higher interest rates and less Fed bond buying it’s a wonder that the markets have not been even more volatile.