Monday, April 10, 2023

Are Markets Whistling Past The Graveyard?

 It's the Monday after Easter Sunday and all markets are closed in Europe in deference to Christ's miraculous rise from the dead.  In some ways, then, it's apropos - if a bit sacrilegious - to mention graveyards.

Here's what's been nagging me for a long time now (at least a year): 

  • There's a major war in Europe which keeps escalating. People are using the word "nuclear weapons" with increasing frequency.
  • Tensions between US and China are high and rising.  The proximate cause is Taiwan, but the major issue here is nothing less than global supremacy.
Both of the above are clear and present dangers, and they are here and now.
  • Climate change is accelerating but no one is really doing anything about it in a practical manner.
The latter is forever talked about as a "future" threat, but I'm increasingly worried that the tipping point is much closer than our society thinks.

IMHO markets are completely (and willfully?) ignoring these risks when pricing ALL securities, from bonds and stocks all the way to commodities and derivatives.  I get the feeling that no one in the mainstream is willing to develop a model to take these into account, perhaps fearing that he/she will be branded a loonie.  

How about this model, then?

Pnwu  = Probability of nuclear weapon use(decimal  0.00 - 1.00)   
Pucc    = Probability of USA/China conflict 
Ptp      = Probability of tipping point within 5 years 

Enwu   = Effect of nwu on equity markets  (+/- %)
Eucc    = Effect of ucc on equity markets 
Etp      = Effect of tp on equity markets 

Cumulative Effect = (Pnwu)x(Enwu) + (Pucc)x(Eucc) + (Ptp)x(Etp)

Plug in your own probabilities and likely effects and you'll come up with something a bit more concrete than "um, let's not worry about it right now".

I'm not doing it, they'll call me a loonie -  Well, at least I'm not doing it in public (ha, ha).


  1. Completely agree with the thesis that assets are grossly mispriced, actually interested in your perspective... do you think this is the single largest mispricing in history?

    On the maths side, I dun think the formula is right... imagine if all the probabilities are one and all the effects are -100%, we would end up with -300%, which is impossible....

    dun think it matters much... but just habitual eh... I think Hell understands by now...


    1. You are right on the maths of course :) I could divide the sum by 3 and be done with it, but that's not right either. The correct way is to do a weighted calculation correcting to 100% max, but ... I like the -300% hahahaha.

      I think the worst ever mispricing in history was the South Seas Bubble. Then again, it was limited in scope. So, maybe yes, today's mispricing is worse because it is based on the massive amount of USD, EUR and JPY liquidity that has been created by the central banks. As such it affects everything from stocks, bonds, commodities and real estate. The entire world is OVERLEVERAGED on a fundamental basis.

    2. yes,... as you say... this bubble is different in that it is caused by the massive overvaluation of the unit of accounting... =)

  2. If there is a nuclear war, equity prices is the last thing to worry about.

    IMO, the only factor that matters today is the Fed balance sheet. QE => higher prices; QT => lower prices. So far, this appears to be the case.