15 May 2013

Arbitrary? Yes. Random? Not So Much. Or Why The Economy Will Get Better Than You Think

The random walk hypothesis is simple. Today's stock prices predict what we know today. Tomorrow we will discover new information and that information is as likely to be bad as good - it is random - so future changes in stock prices are random. Put simply, we can't predict the future.

I think that events are more connected than that, more likely to form a part of larger patterns. And because of that, news tends to come in the form of clusters, bad news bringing more bad news and good news bringing more good news.

Let's take a look at today's news.

Today the non-partisan Congressional Budget Office (CBO) made a huge revision to the near-term deficit projections. By 2015, they are predicting a deficit that is only 2.1% of GDP, an incredible drop from the 10.1% of 2009 in the wake of the Great Recession and comfortably below the 3.1% it has averaged during the last 40 years.
The Dow has closed at new highs in 10 of the last 23 trading days.
Inflation last month was negative.
Unemployment is steadily falling.
Car sales are up about 8% from one year ago.
Home prices in southern California are up 23% in the last year and home prices in the Bay Area are up 17% in just the last month, dramatic examples of similar - if less dramatic - changes around the country.

It is hard to argue that these events are unconnected. Most obviously, an improving economy will make the deficit smaller. But it would be hard to argue that any of the above events are unrelated. A better stock market gives people more confidence to buy things and gives companies more confidence to hire people; as more people get hired, they buy more things; as companies sell more, they hire more people. Effect becomes cause and pretty soon we don't so much see individual dominoes falling as patterns: news about home sales or hiring is slowly displaced by more general reports: the economy is strong. Better news means even more better news.

And that more general pattern is driven by the emergence of simple consensus more than folks care to admit.

Economics is a bit like fashion: it gets defined as much by agreement as "real" issues.

It seems as though communities around the US have begun to build agreement that the economy is good and it is again time to buy homes and stocks and to hire people. That will make it so for months - probably years - to come. That may seem arbitrary but it is not random.

No comments: