During my MBA at Haas School of Business, UC Berkeley, my most favourite subjects were economics (macro, micro) and finance. I really enjoyed topics on how policy impacts countries' economic growth, currencies, interest rates as well as formation and success of businesses. Around that time I also developed interest in "behavior finance". Since then I have always wondered - Is Economics a science of pure math (Equations) or human behavior (Emotions) or mix of both?
In most of the academic history of Economics, it is considered a mathematically precise discipline. There have been few exceptions along the way when in 30's Maynard Keynes suggested that we should also consider Animal Spirits which was taken up as book topic by Yale professor and Nobel Laureate Richard Shiller. This years Economics Nobel was awarded to another practitioner of human side of economics - Dr. Richard Thaler (his book Nudge is my reading list).
In my opinion, Economics as science is best understood when we balance it with:
In most of the academic history of Economics, it is considered a mathematically precise discipline. There have been few exceptions along the way when in 30's Maynard Keynes suggested that we should also consider Animal Spirits which was taken up as book topic by Yale professor and Nobel Laureate Richard Shiller. This years Economics Nobel was awarded to another practitioner of human side of economics - Dr. Richard Thaler (his book Nudge is my reading list).
In my opinion, Economics as science is best understood when we balance it with:
- Mathematics: Rigorous mathematical foundation
- Psychology: Human behaviors
- History: Geo-political and stock markets
Upcoming week also happens to be 30 year anniversary of Black Monday (Oct 19, 1987). On that day DOW crashed by 22.6% (equivalent of more than 5000 point drop in today's numbers). This was largest fall on any single day. There has been extensive study done on causes of crash and many articles/books have been written. No one can precisely point out reason(s) why it happened. Few factors which have led to this largest crash were:
- Markets were at peak after nearly 7 year expansion
- Computers had started taking over large amounts of automated trading
- Republican president was in white house
- Month on Calendar was October (somehow crashes of 1929, 1987, 2008 happened in Oct)
Well - all four factors are applicable today. Does that mean we are heading for something similar and one should convert all of their holdings into cash?
Answer lies into "Psychology" aspect of Economics/Finance. Most of the recent indicators (consumer confidence, unemployment, inflation, interest rates) have been very good. While there is lot of noise in political spectrum, there is general indication that President Trump is going to reduce regulations and taxes which are generally good for growth (unfortunately its not good for environment). Fed is slow and steady in raising interest rates and most likely Trump would nominate market friendly FED president (re-appoint Yellen or nominate Kohn or Powell). Given all these factors, economy would keep on chugging with growth between 1.5 to 3% and that should keep markets at elevated levels for next 6 months. In fact there is fear of missing out which would push people to start investing. When all of these factors converge (similar to what happened in 2000 and 2007), that's time when we would have really reached peak. So the merry-go-round would continue for another six months. If Trump and congress are not able to pass tax reforms by Spring 2018, it may be completely different narrative. We will revisit that in Spring 2018.
Till then enjoy the the holidays. Happy Diwali to all my readers!
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