The stock market is not the economy — but the wild ride of the past 3 days is telling us something really important

Traders, who had been levered up to their eyeballs, are speaking with their risk managers. And their risk managers are explaining that, according to the new model that factors in a new economic reality, they’ll have to borrow less money to play in the market.

Volatility, these killjoys will say, has returned. After laying dormant for months, the VIX, Wall Street’s volatility index, has roared back to life.

“The VIX is now pricing the equivalent of a 2% S&P 500 move up / down each day for the next month,” according to the Chief Investment Office at UBS Wealth Management. “The market-implied probability of another sell-off in excess of 5% over the next two weeks is about 25%.”

In other words, even after the dust settles from the breathtaking sell-off we just saw, we’ll still be living in a riskier world.

Every man for himself

Now, the stock market is not the economy. The economy is doing well. But investors are in fact adjusting to very real changes in economic conditions. It’s a world that’s growing faster, but with more risk.

This is a moment Wall Street has been waiting for since the financial crisis. Not because stocks were overvalued, or because of a Trump rally, or because tax cuts were priced in.

Instead, we have reached the end of an economic cycle of trust.

Some economists, specifically Martin Nowak, a mathematical biologist at Harvard, believe that markets move in cycles of cooperation. When everyone’s working together for a common goal, we get rich. Then bad actors realize they can game the system, and they start misbehaving. Trust breaks down, and suddenly everyone is sniping at everyone else. The market becomes riskier until cooperation is seen as the only remedy. Then the cycle starts again.

For years the world has been coordinating its interest-rate policies, working to ensure a uniform gravitational pull for money around the world. If that’s not cooperation, I don’t know what is.

But as growth takes hold, bringing inflation with it, central banks will have to start looking out for themselves. If inflation in the US does pick up faster than expected, and the Federal Reserve decides to raise rates based on the health of our domestic economy alone (not the world’s), that will shift the gravitational pull of the financial universe.

For central banks, saving the world from getting sucked into a deflationary pull by keeping rates low is no longer their singular concern. It’s every man for himself.


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