Information Cascades and Direct Benefits in Bond and Equity Markets
https://www.bloomberg.com/opinion/articles/2019-11-18/stocks-are-writing-checks-the-economic-data-can-t-cash
https://www.bloomberg.com/news/articles/2019-11-12/risk-is-back-on-as-investors-fear-missing-out-on-stock-rally
This week I wanted to review an eye-catching article I saw circulating on social media from Bloomberg Opinion about how the stock market isn’t really an indicator of how the economy is doing. I’ve recently started to follow the POTUS on twitter and I’ve noticed how quick he is to pat himself on the back for seeing all-time-highs in the stock market and by saying things like:
Walmart announces great numbers. No impact from Tariffs (which are contributing $Billions to our Treasury). Inflation low (do you hear that Powell?)!
— Donald J. Trump (@realDonaldTrump) November 14, 2019
Stock Market up big. New and Historic Record. Job, jobs, jobs!
— Donald J. Trump (@realDonaldTrump) November 15, 2019
as of recently because the stock market truly is seeing record highs- especially in the past month. But is this at all truly related to economic health? This article explains why the growth we’re seeing in the equity market is bloated and how the bond markets are better indicators of economic health- and it really comes down to the distinction between indirect and direct benefit information cascades. The article(s) talk(s) about how the SP500 is trading at some of the highest P/E ratios seen since the 2008 recession and how investors area pouring into equity markets due to this FOMO on this bull rally, when in fact recent sales reports show that consumer demand projections had to be revised to a decline in .1% and GDP has in fact slowed in 2019.
If we are to look at this through a Networks lens, it makes sense why the bond markets behave differently than equity markets: the information disseminated in bond markets that determine bond prices is interest rate changes made by the fed on treasury bonds/notes which tend to not be drastic and hence the information on the yield of treasury bonds tends to be certain to some degree and investors can trade based on legitimate benefit . On the flip side, equity markets are driven by speculation on future cash flows, in which information is only concretely disclosed once a quarter, and it is to the investor’s benefit to follow the crowd intra-quarter. Most of the equity market’s investors are institutions, and individual investors who presumably have jobs and don’t do their complete DD are well off following the decisions of these institutions because of the indirect information conveyed by price swings in an underlying security. Because of this, P/E ratios have blown up and although yes, this does benefit people’s 401ks and retirement plans, it isn’t meaningful seeing as some people stand to lose when the rug gets pulled out from under .