“Rational Irrationality”

“Rational Irrationality” is a concept put forth in a 2007 book, “ The Myth Of The Rational Voter” written by Ben Caplan, an economist attempting to reconcile the widespread existence of irrational behavior in religion and politics.

Simply put, “rational irrationality” is the theory that individuals will relax their intellectual standards and allow themselves to be more easily influenced by fallacious reasoning, cognitive biases, and emotion when the personal cost of erroneous beliefs are perceived to be low, and when individuals place preferences on beliefs for reasons other than the value of the truth. Individuals will engage in asserting preferences, over beliefs based on facts and logic, for the purpose of self-interest, self-image, and social-bonding, and even when preferences reinforce their existing beliefs, regardless of the “coherence with reality”.

During the recent rally from the September lows (as measured by the NYSE Composite Index), we believe that US financial markets have embraced a state of “rational irrationality”, but oddly in this circumstance, the potential personal cost is very high.  

Why?  We do not know.

Our evidence?

The inexorable advance of the major indexes to new highs without the least bit of hesitation or circumspection, regarding negative economic data.  Higher and higher the indexes surge, stoked by cheap and easy money, that fund share buy-backs that “engineer” earnings per share (“EPS”), by increasing corporate financial leverage and risk, while enriching the C-Suite.  These corporate actions are an “irrational” and reckless defiance of nine years of barely perceptible worldwide economic growth, a widespread collapse in commodity prices, years of inadequate business investment (capital spending), low productivity growth, and record levels of worldwide sovereign debt.

Just three months ago, a third straight monthly reading of the Chinese PMI signaling recession would have rattled the worldwide markets to their core.  

Yesterday, the market gave no heed.

In only the last seven sessions, we have noted the following additional negative data.

  • US new home sales fell to 468,000 (15% decline) during the month of September, with a steep downward revision of 33,000 for August.
  •  The General Activity Index for the Dallas Federal Reserve District manufacturing survey was -12.7 down from -9.5 in the prior month.   Any number below -0- indicates a decline, and this is the tenth negative reading in a row.
  •  US Durable Goods orders down 1.3% in September, after a revision in the August decline to 3% year over year. 
  •  US Consumer Confidence declined from 103 to 97.6 in September. 
  •  The Richmond Federal Reserve District General Activity Index turned negative, making it the fifth district that was negative for the month out of the twelve total districts.  The decline of the index was centered in a significant decline of 3% in backlog orders continuing a three month declining trend. 
  • US GDP declined from a 3.9% annual rate of growth in Q2 to a 1.5% annual rate of growth in Q3 2015. 
  • Existing US home sales were down a sharp 2.3% on a month-to-month basis for September.  Annual growth for existing home sales are only up a historically weak 3.0% during 2015. 
  • US Personal income growth for the month was .1% continuing its pathetic track record during the current expansion. Ditto for personal consumption expenditures. 
  • The US ISM Manufacturing Index is skirting recessionary levels at 50.1. 
  •  New orders for the export-hit factory sector fell 1.0% in September for the eleventh decline in fourteen months with August revised .4% lower to a negative 2.1 percent.

So for all of you “rational irrationals” out there who think the possibility of a “bear market” passed…  

We offer only one retort.

In March of 2000, the S&P 500 Index put in a closing high of 1,527.46 before declining 170 points or 11.2% of its value, and closing at 1,356 on April 14, 2000.  Over the intervening four and one-half months, the S&P Index retraced 164 of the 170 points (96.47%) it initially lost from its prior high, before declining 44.54% to the bear market low close of 843.39.

The chart is below.

S&P 500 Index 2000-2002 Bear Market














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