Thursday, January 3, 2013

I Will Never Understand Markets

End of business today:

 To be honest, I think this is an example of (temporary) market irrationality. Just about everybody (who counts) understood that Congress was going to resolve the fiscal cliff before it did any actual damage. A jump of 2.54% is very large for one day of trading and it is entirely attributable to the deal that Congress struck.

Now, in an alternate reality in which both the Democrats and Republicans dug in and jumped off the fiscal cliff together without changing anything for at least a year (a black swan event in and of itself, there is an extremely low probability of it occurring), it's conceivable that the broader market would plunge maybe 20-30% over the course of a few months. So perhaps investors were pricing something like an 8% chance that Congress wouldn't resolve the fiscal cliff before Treasury would be completely unable to forestall its effects.

I think the "correct" price should have been closer to 1%. Time and again we've seen Congress threaten to do something stupid. Like the Democratic House threatening to cut off funding for the Iraq war or for the Republican House and their "refusal" to extend the debt ceiling unless the Democrats agreed to politically impossible spending cuts. It's always a bluff. And it always gets resolved at the last possible moment before things start to go south.

As I've said before. The Republicans and the Democrats essentially agree on 98-99% of current Federal policy. These bitter political clashes are purely entertainment fodder for the masses. The politicians will posture as much as possible until they actually have to do the simple things needed to keep the government operational.

I guess most investors skew risk averse, but in a more perfect market, the continuing resolution and the tax hikes that Congress agreed to would have been greeted with a yawn from Wall Street.

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