Information Cascades in the “Trump” Stock Market
Sources:
Moore, Daniel R. “Trump Pumped Market Ready To Be Dumped?” Seeking Alpha, Seeking Alpha, 16 Nov. 2017, www.seekingalpha.com/article/4125402-trump-pumped-market-ready-dumped/.
As discussed in class and seen in Chapter 22, the stock market is very similar to a prediction market in the following way: individuals make decisions on whether to buy or sell stocks even though the value of the stock is uncertain. The value of the stock varies depending on many states. As Moore shows in his article, one of the biggest factors in determining stock prices are the market’s expectations; these expectations predict how well the stock is doing now and how well it will do in the future.
On one end, we see stocks with lots of “hype” and this interest in a stock can last periodically or even for years on end. The expectations act as an information cascade. A rising stock will influence others to buy the stock since they think the price is going to keep rising, which in turn keeps expectations high and keep the spike going. For instance, this was the situation with Bitcoin. On the other end, it is also common for expectations and demands to drop, as people want to sell or short stocks they think others have low expectations of.
In relation to today’s stock market, Trump’s deregulation and corporate tax cuts are creating very high expectations, but there has to be a conclusion to any aggressive financial run. Moore explains how there exists a “Wall of Resistance” that basically serves as a checkpoint in a financial market. When a stock rises and hits this resistance, the market either chooses to ignore it and the stock price keeps driving higher, or the stock stabilizes. The problem with high increases in price is that eventually, there will be a downturn in the market and the stock will crash.
The “Wall” is a very interesting concept because it shows how quickly an information cascade in the stock market can be immediately overturned when a stock is about to crash. This is because extreme financial stress will build up if the market stays high for extended periods of time. With current expectations, the Federal Reserve System or Fed is at excessively high interest rates and the Treasury has put over $500 billion in new issues into the public market since September. We are currently looking to see Trump’s new legislation on the Tax Bill, which will essentially promote cutting corporate taxes and encouraging capital spending. If the Tax Bill gets passed, we can expect the current high of the stock market to persist into 2018.
However, if the Tax Bill fails to pass, we can expect immediate stock plummet and selloffs as expectations for a “Trump” market will likely disseminate (similar to the drop GE’s stock incurred). It is expected the Treasury will pull back on issuance interest and rates will stabilize.
Ultimately, no matter how driven the market expectations or information cascades are, all it takes is new legislation or a piece of new information to overturn a previous information cascade. In this case, it could cause a powerful downturn in the stock market. This corresponds to the conclusion drawn in Chapter 22; the likelihood of states is very complex and determines whether a stock will rise or fall.