Cognitive Dissonance and the US Stock Markets

Media, politicians and the US stock market operates in a cognitive dissonance. Cognitive dissonance is the confusion arising from the state of holding (Wikipedia.org) “two or more conflicting cognitions: ideas, beliefs, values or emotional reactions”

First the record run in US stocks has been been attributed to “growing confidence in the U.S. recovery” Good news is read as good for stocks, that's as of the other day.

Then today, falling stocks have been imputed to concerns over a pushback on stimulus; “will scale back its stimulus efforts if the labor market continues to improve”. 

Here good news is seen as bad news.

From the above account, one wonders whether the “growing” economy is really good or bad for stocks? Or whether “growth” has merely served as a cosmetic for the deepening addictions by the markets on the FED's steroids?

More rhetorical conflict of rhetoric from Media, Wall Street, and the US government;

On the one hand, the economy has been exhibiting strength for some of the FED officials to propose tapering of stimulus 

A number said they were willing to taper bond buying as early as the next meeting on June 18-19 if economic reports show “evidence of sufficiently strong and sustained growth,” according to the record of the April 30-May 1 gathering released today in Washington.

“Most observed that the outlook for the labor market had shown progress” since the-bond buying program began in September, according to the minutes. “But many of these participants indicated that continued progress, more confidence in the outlook, or diminished downside risks would be required before slowing the pace of purchases would become appropriate.”

On the other hand, Ben Bernanke contradicts the above by stating that the economy doesn’t seem to be strong enough for premature withdrawal of stimulus

Federal Reserve Chairman Ben S. Bernanke defended the central bank’s record stimulus program under questioning from lawmakers, telling them that ending it prematurely would endanger a recovery hampered by high unemployment and government spending cuts.

“A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further,” Bernanke said today in testimony to the Joint Economic Committee of Congress in Washington.

From Mr. Bernanke’s point of view, “premature tightening of monetary policy could lead interest rates to rise” implies the exposing of the risks of the highly leverage markets and economy. And that such tightening would extrapolate to a bubble bust or in economic gobbledygook “the risk of slowing or ending the economic recovery and causing inflation to fall further”

So essentially, people at the Fed have been talking at different wavelengths. Bernanke's discourse has been premised on the entrenched bubble conditions, whereas other Fed officials have used statistics to generate economic forecasts (or reading history as the future).

Thus Fed officials seem as clueless as to the real direction of the economy or of the markets. Or are they?

And a bollixed FED has been used by the stock markets as a reason to retrace. From intraday gains, US stocks went from green into the red yesterday (stockcharts.com)

Record setting US stocks has been on fire rising for 19 straight sessions before today’s correction and whose winning streak was cut short by cognitive dissonance.

Why is this important? Because, aside from direct and indirect interventions, the state of bewilderment of the causal process of the current environment by the media and political agents has contributed immensely to the skewing of price signals and to the accumulation of imbalances in the system. This has also been used to sabotage gold prices.

Well, Philip Coggan of the Economist Buttonwood fame points to studies reinforcing the “parallel universe” or the growing disconnect between stocks and the real economy. (bold mine)

The annualised growth rate of the US economy in the first quarter was 2.5 per cent; the annual gain in earnings per share was 5.2%; the annualised gain in the market was 46%. Of course, as has been pointed out by the assiduous Marsh, Dimson and Staunton, or by Jay Ritter, there is no clear statistical link between GDP growth and equity returns at all.

The mainstream has now been recognizing this.

And as I have been pointing out this is not your daddy or your granddaddy's stock markets.

And more on why the current environment or the parallel universe is unsustainable, again from the Buttonwood… (bold mine)

The hope is that higher share prices can eventually produce a self-fulfilling cycle via a wealth effect (and on this note, the University of Michigan survey last week showed consumer confidence at a six-year high) or indeed on business investment. Mr Makin notes that real household net worth is up by about $4 trillion over the last year, helped by houses as well as stocks. He estimates the wealth effect at about 4% over a year; thus the boost to consumer spending was $160 billion, or 1% of GDP. This may indeed explain why US consumer have shaken off the effect of the rise in payroll taxes this year.

But the offset of this wealth effect is that the household savings rate fell to 2.6% in the first quarter, down from 5.1% in 2010. As Mr Makin points out, this is ominously similar to the pre-2007 pattern of high consumption based on the hope that asset prices would stay high. The potential long-term problem here is that asset prices tend to revert to the mean; people may be saving too little for their retirement on the view that markets will do all the work. As in 2007 and 2008, they may get a nasty shock later on. One could make quite a bearish case for US equities in the long run, on the grounds that share price valuations (as measured by the Shiller p/e) are higher than average and profits are at a post-1947 high as a proportion of GDP.

The lesson is whatever statistical growth seen from today is mostly a reflection of credit driven elevated prices of financial assets rather from real economic growth. The same holds true for the Philippines. 

The mirage of statistical growth. 

Hence Ben Bernanke realizes that any pullback of steroids would expose on this sham that would undermine the banking sector’s balance sheets.

Also an ‘exit’ would also mean the pulling of the proverbial rag underneath the FED’s monetization of US debts which hardly anyone talks about.

Bottom line: The protection of the banking sector and the Fed’s financing of US government debt have been the main pillars that undergirds the FED’s credit easing policies. That’s why such “exit” or “withdrawal” blarney are what I call as poker bluff. The Fed cannot afford it.

IN withholding the truth, the Fed’s communication’s strategy seems as the guileful employment of cognitive dissonance in order to confuse the public.

As English novelist Eric Arthur Blair popularly known for his pen name George Orwell wrote in Politics and the English Language (italics original)

Political language…is designed to make lies sound truthful and murder respectable, and to give an appearance of solidity to pure wind. One cannot change this all in a moment, but one can at least change one's own habits, and from time to time one can even, if one jeers loudly enough, send some worn-out and useless phrase — some jackboot, Achilles’ heel, hotbed, melting pot, acid test, veritable inferno, or other lump of verbal refuse — into the dustbin where it belongs.

The Low Correlation Between the Stock Market And Economic Growth

Analyst John Mauldin cites Crestmont Research’s Ed Easterling who argues “stock market is not correlated with economic growth”.

They say “secular bear markets even have higher nominal GDP growth than secular bulls”, with the chart below as proof…

And also say “34% of the years since 1950 with economic growth have experienced declining earnings per share (EPS) growth!” Again a series of chart below as proof…

I am puzzled.

If “low correlation” means economic growth has not functioned as a good indicator of the direction of the stockmarket price trends, then why the heck, do these experts keep talking about various aspects of “economic growth” at all? This is obviously a cognitive dissonance.

One factor for the insistence of the “economic growth” conversation could be that they don’t agree with the referenced opinion.

A second factor could be entertainment value. Experts write to entertain more than to disseminate positive knowledge.

A third factor could be to use of such contrarian evidence as cover to their earlier misdiagnosis of the markets and the attendant mistakes in prediction.

Finally this could all be about social signalling.

Yet this just goes to show how more and more ‘experts’ appear to be getting lost or confused about what’s been going on. In other words, traditional methodologies and metrics are becoming more dysfunctional.

And all this provides more credence to what I’ve been saying all along.

Cognitive Dissonance: Associating MENA Political Crisis Or Oil Prices With Weak EM Equities

Listening to media and to their “experts” or to mainstream chitchats will give you a false impression of what’s been happening.

Some would claim the Middle East has been causing market turmoil.

On the other hand, others will claim rising oil prices has hurt the EM equity markets.

Let’s put into perspective the reality of the current situation as seen by the above chart. (pls pay close heed)

By the way, here is the time line of the MENA’s (Middle East and North Africa) revolt against autocracy.

The best view for this interactive chart is to go the Wall Street Journal here

The important point is to show you WHEN all these began—January 9^th. (you may want to include Algeria’s food riot 3 days earlier)

So what do all these tell us?

-The fall of emerging market equity prices began last December as OIL prices in general continued to climb. In fact, the initial downturn of EM equities coincided with the WEAKENING of oil prices. But oil reversed and rallied.

-Emerging equity markets has been on a decline WAY BEFORE the domino like political crisis in the Middle East and Africa (marked by the blue vertical line).

-Oil prices have been on the rise WAY BEFORE the MENA Political crisis

-The US S&P 500 has been on a winning streak and only materially declined yesterday.

So has rising oil prices and or the Middle East crisis has caused the decline in EEM? The answer is clearly NO!

The correlationship of the Middle East crisis, oil and Emerging markets appear to be tenuous, i.e. correlations have been starkly weak.

Yet to argue that Middle East or High Oil Prices equals WEAK global equities is no more than cognitive dissonance or in my terminology popular “superstitions” or in Taleb’s lingo, “Negative Knowledge”.

People are simply trying to grope for an explanation and would take any events to confirm or to read by the market’s action.

Instead the role played by the Middle East Crisis to the current EM equity infirmities has been as an AGGRAVATING CIRCUMSTANCE to an already existing condition.

Those who took action because of the alleged Tunisia-Oil-Equity relations are plain LUCKY, for the simple reason that to argue base on this premise has been simply false.

I’d like to further add that to my observation NO EXPERT PREDICTED this MENA political crisis to happen or unfold as it has today.

While the MENA crisis has been long overdue, and has been predictable, as current political structures and system are simply unsustainable, what has been unforeseen is the timing and the scale of contagion.

Take for instance, Dr. Marc Faber, as previously pointed out, rightly predicted on the weakening of the emerging market stocks in the end of 2010. But he didn’t foresee this political crisis unfold (although his prediction of an Israel-US air strike on Iran since has not materialized. Generally speaking, he’s been spot on).

So current conditions have only coincided or buttressed Dr. Marc Faber’s general perspective of the weakening of emerging market equities.

Bottom line: the MENA crisis serves only an aggravating circumstance, not the cause of weakening EM equities.

I’d like to add that MENA political crisis is an upheaval against dictatorship regimes whom had been US puppets.

Yet violence is likely to remain local, as the incumbent autocracy will stubbornly resist relinquishing power which they see as an endowed entitlement.

Nevertheless, it is a positive outlook to see people start to be appreciative of freedom or liberty, even if many have misplaced ideas about what constitutes genuine liberty.

In watching a live interview broadcast in Aljazzera, two Middle East experts seem to acquiesce on the root of the unrest: economics—where the current system has only channelled wealth redistribution to the privileged political class at the cost of the public.

However, in contrast to common impression about Islam Dr. Mark LeVine says that he’s been amazed by how Islam authorities have been urging people to revolt peacefully in spite of government actions.

So while there may be some risks of a militant Islam theocracy taking over, he thinks that this may be overrated.

I agree, people are starting to learn about the difference between top-down and bottom up political structures. Thus, this is no reason to be bearish.

Note: People believe whatever they want to, some to the point of deluding themselves.

I am interested in positive knowledge or what works. This means reading through all the facts rather than selectively taking in facts that only conforms to a preconceived conclusion.

Blind Faith Analysis

Arguing political or economic issues based on biases, in my view, seems similar to layman’s argument in the context of religion.

They are hardly grounded from reasoning but from ‘blind’ faith.

Well, it’s interesting to know that in surveys, a vast number adherents of world religions fundamentally know less about their ‘beliefs’.

This from Pew Research

More than four-in-ten Catholics in the United States (45%) do not know that their church teaches that the bread and wine used in Communion do not merely symbolize but actually become the body and blood of Christ. About half of Protestants (53%) cannot correctly identify Martin Luther as the person whose writings and actions inspired the Protestant Reformation, which made their religion a separate branch of Christianity. Roughly four-in-ten Jews (43%) do not recognize that Maimonides, one of the most venerated rabbis in history, was Jewish.

In addition, fewer than half of Americans (47%) know that the Dalai Lama is Buddhist. Fewer than four-in-ten (38%) correctly associate Vishnu and Shiva with Hinduism. And only about a quarter of all Americans (27%) correctly answer that most people in Indonesia – the country with the world’s largest Muslim population – are Muslims.

Professor Bryan Caplan adds a brain twister to what he calls rationally ignorant,

Now consider: If people sincerely believed that their eternal fates hinged on their knowledge of religion, their ignorance wouldn't be rational. If you could save your soul with 40 hours of your time, you'd be mad to watch t.v. instead. Unfortunately for religious believers, this leaves them with two unpalatable options:

1. Option #1: Deep-down, most religious believers believe that death is the end. (This is consistent with the fact that even the pious mourn their loved ones at funerals, instead of celebrating the good fortune of the deceased). Even if this covert atheism is mistaken, the idea that most of the people in church aren't true believers seems threatening.

2. Option #2: Most religious believers are so stupid and/or impulsive that they'll knowingly give up eternal bliss for trivial mortal pleasures. But why then do so many believers show intelligence and self-control in other areas of life?

Strange or self contradictory as this is, rational ignorance only goes to show that what most people believe in runs in contrast to their actions.

And applied to economic and political analysis, blind faith analysis is simply cart before the horse logic; of which the common characteristics are: they are full of factual errors, the frequent use of logical fallacies, deliberately misinterpretation of theories, ambiguous definitions and data mining or selective application of evidence.

Signs of Bond Bubble: Clashing Price Dynamics of US State CDS And The Treasury Market

Here is an example of the market’s current cognitive dissonance.

In the US, as many as 5 states appear to be having serious credit problems and are presently being reflected on the Credit Default Swaps (CDS) or the cost to insure a bond.

One might say that they are the US equivalent to Europe’s version of the PIIGS. We made an earlier similar observation here.

According to Bespoke Invest (chart also from them),

The number next to each state represents the cost per year to insure $10,000 worth of state bonds for 5 years. The higher the price, the higher the default risk. As shown, Illinois has the highest default risk of all states at 303.2 bps -- even higher than California. California ranks 2nd, followed by Michigan, New York, and New Jersey. Not to anyone's surprise, these are basically the five states in the country with the biggest fiscal problems at the moment. States that appear to be in pretty good shape include Texas, Virginia, Maryland, and Delaware.

As you can see the credit problems are NOT being reflected on US treasury yields (10 year TNX), which seem to ignore the developments in the CDS markets.

In contrast, the Eurozone recently had a fit of convulsion over the Greece-led PIIGs episode.

And instead, the US sovereign papers are seen “safety” assets where an ongoing onrush appears to be taking place as the mainstream hollers about “deflation (!)”.

In short, you have two markets seemingly headed for a collision course. This means one of them is decisively wrong.

For me, this represents part of the massive distortions engendered by interventionism. And vastly skewed prices have been misleading investors (led by the retail-dumb money). The treasury markets increasingly look like a time bomb, in the perspective of a ‘bond bubble’, set to implode.

The other way to say it is that if those credit woes exacerbate, then eventually, they will be vented on the treasury markets.

Caveat emptor.