Nov

8

With the recent success by Democrats in the House of Representatives and in the Senate, coupled with the recent rally in the US stock markets there are some thoughts that come to the surface.

A quick review of Adam Smith’s comments:

In 1776 he wrote “An Inquiry into the Nature and Causes of the Wealth of Nations” in which he promulgated his invisible hand theory, which stated that each individual, while striving for his own gain, of necessity advances the public interest by the free exchange of goods and services creating division of labor and a free market economy.

Some natural questions:

Gary Rogan replies:

The market is obviously saying that major pharma, HMOs, and large defense contractors are likely to lose. It’s re-valuing non-dividend-paying stocks slightly higher relative to dividend-paying stocks and smaller stocks slightly higher than large-caps. It obviously thinks that gridlock is good, and it seems to have preferred the House and Senate to be controlled by different parties, at least as far as above-mentioned groups are concerned. Overall, it’s happy with the results.

The only thing that’s likely to get done for sure is “immigration reform”. Whether that’s good or bad is in the eye of the beholder. I think it will be a long-term disaster, but the short-term economic impact just isn’t enough to worry the markets.

The market got the big picture correct, the House situation and the Republican loss of control, because it was a relatively well-behaved stochastic event that could be pre-sampled and processed, but couldn’t deal with the Senate because it simply could not have known what fewer that ten thousand people who decided the election in Virginia and Montana would do. This illustrates perfectly both the power and limitation of markets: they deal with distributed information better than almost any individual, but fail with highly non-linear situations where small noise-like perturbations are amplified dramatically in a digital fashion to produce a significant outcome.

Rick Foust adds:

I just had a visit with a good friend and fellow engineer here in the risk-averse world of nuclear power. He is a devout Democrat and Bush-hater. He has been strongly bearish since 2001. I have pulsed him since 2003 when I first advised him to become bullish. He has consistently responded that everything is horrible and will stay that way. In return, I have teased that when he finally turns bullish, I am going to sell everything. This teasing has only strengthened his resolve. Today I asked him how he is feeling now that Washington power is shifting. He tells me that today he increased his 401K contributions and the increase is going to stocks. His choices are popular with risk adverse engineers: Fidelity Magellan, FMAGX, and Fidelity Equity Income, FEQIX. He believes that the market does better when the power in Washington is divided. He is eagerly anticipating trouble for Bush. If I am guessing correctly, he will be right (for a while) and one day he will come to my desk gloating over how the market has advanced coincident with Democrats’ taking vengeance on the Evil One. I will sell on that day.

 


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