Uncertainty

Since the beginning of 2017 high political uncertainty in the US has coexisted with very low stock volatility. Should we be puzzled? Not really argue Pastor and Veronesi because the positive relation between political uncertainty and volatility implies a strong and constant “political signal”. The new administration’s political signals have been full of reversals and contradictions and therefore difficult for investors to interpret. As market participants become skeptical about announced future policy actions the link between stock volatility and political uncertainty weakens.

Explaining the puzzle of high policy uncertainty and low market volatility
By: Lubos Pastor, Pietro Veronesi – University of Chicago

Aswath Damodaran agrees that the US stock market is indeed signaling a period of stability. More money has been invested in equity and bond funds since November 2016 than in the first ten months of 2016, as the graph below shows.

For S&P equity premiums the picture is more nuanced: their expansion has been sustained by low interest rates and large stock buybacks.

Damodaran’s conclusion? “[…] we could be on the verge of a sharp surge in stock prices or a sharp correction, entering an extended bull market or on the brink of a bear market, at the cusp of an economic boom or on the precipice of a bust.”
A Tale of Two Markets: Politics and Investing!
By: Aswath Damodaran – New York University

In this paper, Hansen and Sargent examine whether responses to modest amounts of model ambiguity can substitute for the implausibly large risk aversions seemingly required to explain observed market prices of risk.
“[…] the tools developed here could shed light on a recent public debate between two groups of macroeconomists, one prophesying secular stagnation because of technology growth slowdowns, the other dismissing those pessimistic forecasts. The tools that we describe can be used, first, to quantify how challenging it is to infer persistent changes in growth rates, and, second, to guide macroeconomic policy design in light of available empirical evidence.”
Prices of Macroeconomic Uncertainties with Tenuous Beliefs
Authors:Lars Peter Hansen, Thomas J.Sargent
From: University of Chicago – New York University