As October draws to a close, I find myself reflecting on how difficult a month it has been, and on the degree to which the month’s events reflect issues about which I have been writing in my past blog posts.
Early this month, I planned this post to appear on October 29, the anniversary of the stock market crash of 1929. Certainly this October has been a dramatic month for stocks; however a lot more has happened this month to merit our attention than stocks declining. For this reason, I will offer a few remarks about stocks, and then move to some of the other issues that I suggest we would do well to keep salient.
The crash of 29 resulted from stocks being overvalued in 1929. My posts over the last eighteen months have sent a consistent message that U.S. equity markets are at least 20% overvalued relative to underlying fundamentals. Stocks that are overvalued relative to fundamentals effectively qualify as what the late economist Hyman Minsky called “speculative finance.” This is because the expected free cash flow streams associated with these stocks, and their companies, are insufficient to support the current market valuations.
Although the Federal Reserve is doing its best to engage in sensible monetary policy, I do not see evidence that Fed chair Jerome Powell fully appreciates Minsky’s lessons about speculative finance. Moreover, I have also expressed concerns that President Trump’s criticism of Fed policy, coupled with his own aggressive trade war initiatives, are injecting a lot of risk into the global economy.
At last weeks’ close, the S&P 500 had declined by just over 9% during October. The six major technology stocks—Facebook, Apple, Amazon, Netflix, Google, and Microsoft had declined by over 12%. As significant as this feels, year-to-date the S&P 500 was only down by about 1.5%. Amazingly the six technology stocks were still up almost 20% for the year: the average high water return for these stocks this year has been 48%! There is a lot of room for stocks to fall before they reach fundamental value; and this should give us pause.
More troubling than stocks being overvalued is what is happening to the culture of our country. Last week, a series of pipe bombs were sent through the mail to prominent opponents of President Trump’s policies. This past weekend, a white supremacist killed eleven people who were praying in a synagogue in Pittsburgh. President Trump indicated that he would visit Pittsburgh as a show of support, but Pittsburgh Jewish community leaders responded to say that he is unwelcome unless he denounces white nationalism. I think they are right to do so. In my previous writings, I joined many others to warn about the consequences of President Trump’s embracing white extremists.
In those same writings, I pointed out that the failure of Democrats to turn out to vote in 2016, in key states, made the difference between having Donald Trump as President or Hillary Clinton. I expressed my concern in 2016 just before the election, and I reiterate that same concern now in respect to the midterm elections.
I save what I believe is the worst for last. This month, the world’s leading experts on global warming stated that conditions are worse than previously thought.
I have been following the predictions made by climate scientists for decades, and their greenhouse gas-based climate predictions have turned out to be more accurate than the market predictions made by financial experts. Climate scientists’ past predictions about drought, fires, and hurricanes are now playing out from California to Florida. This year my home state of California experienced some of the worst wild fires on record; and just this month, Hurricane Michael did record damage in Florida.
Earlier this month, the Economics Nobel committee announced that this year’s award would go to William Nordhaus and Paul Romer. Nordhaus especially is well known for his work advocating sensible climate policy. Sensible policy involves pricing greenhouse gases appropriately on a global basis. Markets have a role here.
Policy makers around the world, especially those here in the U.S. would do well to implement Nordhaus’s prescriptions. I have been warning about President Trump’s dangerous policy decisions on climate from the time he took office. It is clear that his policies, and his stated view that climate change is not man-made, have great appeal to his political base. Unfortunately for all of us, his political base is dangerously wrong on this issue; and this is not my opinion alone, but the position of virtually every mainstream climate scientist.
A lot of people put their faith in financial markets, and financial markets are not sounding major alarms about climate change, at least not now. Markets do sound alarms, but usually very late in the game. You only have to think back to the lead up to the financial crisis to see that this is the case.
As a behavioral economist, I study the psychological pitfalls that have led so many to hold biased views about stocks and about climate change. Biased views about stocks do not present a major threat to the planet; however, biased beliefs about climate change do. To be sure, the Intergovernmental Panel on Climate Change (IPCC) is quite clear: If we don’t find a way to avoid these biased beliefs about global warming, life on our planet will be change drastically for the worse; and this will happen within the lifetimes of many of those around today, including climate change skeptics.
This has been a very bad October. The situation with overvalued stocks is worrisome. The situation with white supremacists who express themselves through violence is horrible. Unless we act quickly, and with courage, the situation with climate change skeptics who stand in the way of sensible climate policy will deliver a future that is truly terrible. If the past offers any indication, it is that financial markets will reflect that future, but only very late in the game.