Summary: Brad Delong (Prof Economics, Berkeley) reminds us that on this day in 1914 the NYSE ended the longest period of stopped trading. The outbreak of war on 31 July triggered “the longest circuit breaker” in NYSE history. His post, as usual, gives an interesting account of that episode. Who closed the NYSE, and why? There is another lesson from this history, one of importance to us today. (This is the second of 2 posts today)
“Unless you expect the unexpected you will never find truth, for it is difficult to discover.”
— Heraclitus, the pre-Socratic “Weeping Philosopher” of Ionia
Stock market strategists and economists often tell us about markets’ fantastic predictive ability (an emergent phenomenon from millions of investors), often to the extent of referring to stock prices as a barometer of economic health. Count me among the skeptics when it comes to forecasting.
Here’s a survey of risks by Nial Ferguson (Prof History, Harvard), typical of those before the 2008 crash. He doesn’t even mention the structural weakness of banks, the factor converting a real estate downturn into a global crash. But then nobody saw this (that I’ve found).
Even in what investors should see best — economic cycles — their record is mixed. Sometimes the market gets it wrong; the October 1987 crash predicted nothing. Sometimes the market sees things a little late: the Great Depression began as the US economic downturn began in August 1929; the stock market crashed on October 29 (timeline here). Sometimes the market gets it right: the stock market peaked on 9 October 2007, the recession began in December, the economy crashed in Fall 2008 (timeline here).
Geopolitics have an immense effect on markets. Here economists have very poor record of forecasting, although they often see themselves as bookies of geopolitics (they tend to be hawks, which is odd given the horrific history of war’s effects). Likewise, investors poorly assess geopolitical threats. On this 100th anniversary of WWI let’s see how well investors anticipated that climatic event (timeline here).
In hindsight WWI looks almost inevitable. Historians see its origin in two decades of rising geopolitical tensions among the major western powers as William Lind explains. Yet investors back then didn’t feel rising tension. For a scholarly yet readable account I recommend Nial Ferguson’s “Earning from History? Financial Markets and the Approach of World Wars” (Brookings, Spring 2008), which provides the quotes below. An assassin killed the Archduke Franz Ferdinand of Austria on June 28. In the following month stock prices declined throughout the western world. Prices of US railroad and industrial shares dropped 15%. The Vienna stock market crashed on July 13.
Although selling spread of stocks and intensified, investors in most assets in the so-far unaffected nations remained calm (the bond markets dwarf stocks in size). Similar crisis had been resolved through diplomacy. Europe had not experienced widespread war for a century. Compelling analysis by experts such as Jan Gotlib Bloch (Is War Now Impossible?) and Norman Angell (The Great Illusion) proved war to be irrational and hence unlikely.