Some risks are hard to price.
Photographer: Kazuhro Nogi/AFP/Getty Images
Last week's stock market action will come as no surprise to people who closely follow investor behavior, particularly those who are students of behavioral finance. It will also reconfirm already entrenched adaptive expectations that have conditioned investors to buy the dip — a behavior that has clipped considerably both the duration and extent of market sell-offs.
In a week of notable moves in the fixed-income and currency markets, including the 10-year U.S. Treasury's decline to a 2017 low and the dollar's weakening to levels not seen for almost three years, U.S. stock indices recovered impressively from a rough first day of trading. By the end of the week, the Dow Jones Industrial Average was essentially unchanged, while the S&P slipped just 0.6 percent and the VIX edged up to only 12.1. In the process, stock investors again put behind them big unresolved issues regarding North Korea's nuclear threats, significant actual and projected damage from two monster hurricanes, added uncertainties about the future leadership of the Federal Reserve, and a significant downward revision in Japanese growth.
Admittedly, there was also favorable news last week for markets. The European Central Bank revised upward its growth projections, while a surprise deal between President Donald Trump and congressional Democrats removed the specter of an October breach of the debt ceiling and the government running out of funds. At the same time, remarks from Fed officials pushed back investors' timing of the next interest rate increase, reducing the implied market probability of a December hike to just under 30 percent.