How long do you think market is predicting the recession to last?

There's predictions expecting 30% unemployment since March for Q2, and also predictions expecting 50% GDP drop for Q2.

So current market should have these predictions priced in.

I think one major thing that people fail to consider is that this recession is not like other recessions - namely, it's not failing of economics, or a bubble popping, it's a temporary natural disaster and economy is deliberately shut down. So it shouldn't be compared to other recessions which were issues with how economy worked. Right now there's no evidence that economy or system is failing by itself. Of course it might, but there's no evidence.

I think current market price stems from rational strategy by investors. This is why I think markets are rational. Current recession doesn't have implications 5 years into the future. We might lose some potential developments we could've had right now, but it just gets delayed few years, so it's not a big deal.

Maybe it is hindsight to me, but to me it seems clear why stock market has the current price it is. Maybe I'm "overfitting" somehow my theory, but it seems to make sense to me and I'm not seeing a clear logic error with my theory. I've argued a lot on this topic on this forum and reddit, and I haven't seen good retorts yet, it's just that I'm not getting any responses or somebody says "I just disagree and that's it".

If it lasts long enough, a temporary natural disaster becomes an economic disaster.

I think the rough market consensus at the moment is as you state it - this is a natural disaster which will be over soon. That is a possible outcome at this point, but a second wave in the US for example would have significant impacts and cause entire industries to fall into bankruptcy - wiping out shareholders and leading to significant second-order effects on other industries and supply chains, plus causing a consumer-led recession. It seems increasingly unlikely to me that this will be over as soon as you expect. Just to pick one example - that 20-30% unemployment will not go away quickly if this is not over in the next month or two for the US and those people rehired. Companies will not rehire unless they are certain it is over.

Current recession doesn't have implications 5 years into the future

Remind me in 5 years! I don't think it will impact behaviour massively in 5 years, but I do think there is a danger this recession could trigger significant other events which have impact for more than a few years - for example unrest in the middle east after 2008 led to regime change in many countries, and ongoing war in Libya. Economic depression, unrest and wars are a common occurrence after smaller crises than this one.

When people say the market is irrational it is more to point out that the market valuation swings about the future expected returns quite wildly - for example if what you say is true, the market should not have crashed quite so strongly when coronavirus first spread then bounced back quickly again, but it did, because people panic. It does the same in the opposite direction based on incomplete or incorrect information about drugs/vaccines. There's a nice graph in the above book of the expected return from stocks (pretty much a straight line up and to the right, with small bumps on the way), and stock market valuations (massive swings around the expected return based on sentiment in that moment).

How do you determine whether it was panic or just uncertainty?

It could be a rational reason for markets to swing wildly because of uncertainty about future. It might take time to gather enough data to assess the risks properly, and while risks are as unknown it is rational that market will be valued lower.

Each bit of knowledge makes uncertain a little bit less uncertain.

I don't think we know enough to decide why markets swing wildly around the actual return, but that they do is demonstrable fact.

I haven't read the book, but do you know where the expected returns (the straight line you mention) come from?

This lecture contains a similar graph on asset prices - he uses returns from the S&P for the period 1871-2013. The book really is worth a read too, it's more accessible than the lecture or slides might indicate.

https://www.gurufocus.com/news/336523/speculative-asset-pric...

https://www.nobelprize.org/uploads/2018/06/shiller-lecture-s...

The comparison is between the actual stock prices against the constant discount rate of subsequent real dividends.

Day to day prices are unforecastable, and it's not really understood what drives pricing in the market.

> The comparison is between the actual stock prices against the constant discount rate of subsequent real dividends.

The EMH states that the market incorporates all currently available information, but future dividends are known only in hindsight. Prices that fluctuate around future earnings therefore are not in conflict with efficient markets at all.

I'd recommend the book if you haven't read it, I don't think my poor summaries do it justice, and it does address some of your objections from memory, and also doesn't attempt to throw out EMH, just questions whether it fully explains market behaviour.

Yes the chart compares measured return (divs) against projected return (prices) so it is not a prediction machine but I think it does illustrate well that market prices are usually far from true value.

If you think there's a significant chance the market is wrong in its assessment of risk, you can make a significant amount of money by betting against it. For example, as of the time of this writing, put options at $310 for December 31 on the S&P 500 (current price $293.94) cost $33.09. That means that if there is at least a 50% chance of a 17%[1] drop in value of the S&P 500 at any time between now and December 31, you can make money on average by buying those puts and selling them as soon as prices are down by 17%. The possibility of making this bet means that the market as a whole is 50% confident that stock prices of the S&P 500 will not drop by at least 17% before December 31.

Likewise, option prices imply:

- A 75% chance[2] prices won't drop by 26%+ (which would be back around the low from late March 2020) by the end of the year

- A 90% chance[3] prices won't drop by 48% or more (around the movement from when it became clear that something was deeply wrong in 2008 to the bottom)

- A 95% chance[4] the price won't drop by 58% or more (which is around the peak-to-trough movement from the 2008 financial crisis)

- A 99.5% chance[5] that the price won't drop by 90% or more (like the great depression).

While it's _possible_ that the market is wrong about its assessment of risk, that would also mean that it's wrong about its assessment of its assessment of risk, and people who are better at risk assessment could clean up.

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[1] Ok, technically a 50% chance of a drop of 17.05%. ($310 - ($293.5 * 0.8295)) / $41.75 == 1.9999 i.e. if you buy now and sell as soon as the price drops by $17.05, you make a 2x return on investment.

[2] $20.77 for $280 puts expiring Dec 31

[3] $4.62 for $200 puts expiring Dec 31

[4] $1.83 for $160 puts expiring Jan 15. I actually have a small position here, because "95% chance this isn't at least as bad as the 2008 financial crisis" seems a bit overly optimistic to me.

[5] $0.16 for $75 puts expiring Jan 15. Note that there is extremely low volume this far out on the tail.

The market is usually wrong, but it's very hard to know when it will stop being wrong in one direction and start being wrong in the other (as in the great depression say).

"The market is wrong but not in any way that's possible to make concrete predictions about ahead of time" and "the market is correct relative to available information" seem like functionally identical statements to me.

Unless you mean something stronger than "today's price usually isn't the same as next year's price after taking into account the discount rate" by "the market is usually wrong".

Just because you can't predict it in the short term doesn't make it correct or efficient in the short term, it is only correct in some sense in the very long term.

What does 'irrational in important ways' even mean? What Shiller has shown is simply that the idea of a perfectly effecient market is self-contradictory. Efficiency is just a very good approximation in practice.

I believe he shows in that book it's not a very good approximation - the market oscillates from overshooting to undershooting actual returns, and I don't think he believes market movements are always based on rational decisions, hence the title of the book.

> I believe he shows in that book it's not a very good approximation

But what does that mean? What is a good predictor of future returns and what is not? If markets are not, what is?

> the market wildly overshoots and undershoots actual returns

Well, the actual returns are only known retrospectively, but the current prices have to reflect all future returns. So, of course, current prices will always be wrong, that's not surprising at all.

You seem to be saying that current prices are always wrong, but less wrong than estimates of future prices based on current prices.

I have to admit to being surprised by this line of argument.