Manny Mondays - Are The Markets Mispricing Risk....Again?

Morning all! Late Friday afternoon I threw out the question of whether or not the markets were being a bit too "complacent" in light of the Japan situation and an increasingly unstable geopolitical situation in North Africa and the Middle East. I've been of the mindset that this environment is eerily similar to the complacency (or resilience, whatever one wishes to label it) that we saw in the markets in late '07/'08 (remember, "subprime is contained?") when most of the dips and corrections were continually bought all the way until September '08 when it all came crashing down, launching us on a ride of epic proportions for the next fix months until the lows in early March '09. Since then it's been up, up and away for the markets with any/all shallow dips being forcefully bought.

Well, lo and behold, I noticed the following NY Times article by Jeff Sommer that ran on Saturday night which addresses this issue, among other related ones, and asks whether or not the markets can truly "grasp" (or have its prices accurately reflect) the fallout from the current crisis (I would say CRISES, plural, but never mind):

A Crisis That Markets Can’t Grasp

A couple of key excerpts:

Like everyone else, corporate executives, economists and financial analysts in Tokyo, New York, London and beyond struggled last week to wrap their heads around the scale of this disaster. But, as they so often do, the analysts quickly fell to work assessing the implications for companies, markets and economies. At times, it was almost surreal: On Tuesday, Laszlo Birinyi, a prominent stock market analyst based in Westport, Conn., e-mailed around a succinct report titled “Nuclear Meltdowns at a Glance.”

This is what happens on Wall Street. If you’re not immersed in the culture, it might be hard to understand the cool calculus that is applied to world events, however dire those events might be. After the quake hit on March 11, the CNBC anchor Larry Kudlow told viewers, “The human toll here looks to be much worse than the economic toll, and we can be grateful for that.” He later apologized.

Later in the article, Sommer also invokes the name of Nassim Taleb of "Black Swan" fame:

Nassim Taleb, the author and market theorist who popularized the phrase “black swan” in his 2007 best seller, argues that we have psychological biases that blind us to the enormous role played by rare events — like a 9.0-magnitude earthquake. And yet we rely on history for guidance.

According to the article, despite these seemingly circling black swans (or least gray ones), the S&P only went down 1.9% for last week, and market strategists such as Birinyi and Lakshman Achuthan remain bullish on the prospects of the U.S:

On Wednesday, Mr. Birinyi’s research firm sent out another report, this one titled “S.& P. 500 Enters Modest Correction.” His firm predicted a slight decline in the American stock market.

“If the averages hold,” the report said, “the S.& P. 500 will bottom at 1,232 on 3/31/11.”

Lakshman Achuthan, the managing director of the Economic Cycle Research Institute, a private forecasting group with an excellent track record, says that Japan’s economy, which he believes is already in recession, won’t appreciably affect the direction of the economy in the United States. The disaster, however, “ensures that Japan is in a recession,” he said.

As Sommer points out, the markets are essentially "highly complex counting machines" with day to day movements mostly being the "white noise of global capitalism". So how do we know the markets are now accurately pricing in/reflecting the risk of everything abroad and the headwinds here at at home going forward (e.g. ahem, a continually, slowly deteriorating housing market, stagnant job market & small business environment, etc.), especially since everything in our global economy and markets are now so tightly linked, and in light of an historic rally from the March '09 lows? Most importantly, how can we not question things a little now after we saw how badly mispriced risk, and the markets, were at key times during the height of the dot.com and recent credit/housing bubbles? Be sure to go read the whole article and let me know your thoughts.

On another note, Manny Mondays will be out of commission next Monday, so there will be no post from yours truly. Anyone want to take that day and post something in my absence? I'll be back the following Monday, April 4th!