Timorous evidence of “Contagious Effect” after Dow Sell-Off.

The stock market seems to be returning to the old normal of higher levels of volatility. I suggested on Tuesday that former Fed Chairman Alan Greenspan’s comments could have brought back volatility by triggering the Dow Sell-off on Monday, February 5th. As I wrote early in the week, I believe that we should observe some panic manifestation of economic anxiety because of Mr. Greenspan’s comments. In this Blog Post, I will show two Person Correlation tests that may allow inferences as to how investors’ fear has grown since Mr. Alan Greenspan stated that the American Economy has both a Stock Market Bubble and a Bond Market Bubble. The Pearson correlation tests show that the correlation has strengthened during the last seven days (First week of February 2018), suggesting there might be symptoms of Contagious effect.

I correlate two variables taken from two different time frames for the fifty states. First, the natural logs of the search term “Inflation”; and, the natural logs of the search term “VIX” (Volatility Index). Second, I correlate the natural logs of the same searches for both the last seven days period and the previous twelve months period. By looking at the corresponding coefficients, one may infer that the correlation increased its strengthen after Mr. Greenspan Statements -which reflects on the last seven days data. The primary goal of this analysis is to gather enough information so that analysts can conclude whether there is a Contagious Effect that could make things go worst. Understanding the dynamics of economic crisis starts by identifying the triggers of them.

What is Contagious Effect?

I should say that the best way to explain the Contagious Effect is by citing Paul Krugman’s quote of Robert Shiller (see also Narrative Economics), “when stocks crashed in 1987, the economist Robert Shiller carried out a real-time survey of investor motivations; it turned out that the crash was essentially a pure self-fulfilling panic. People weren’t selling because some news item caused them to revise their views about stock values; they sold because they saw that other people were selling”.

Thus, the correlation that would help infer a link between both expectations is inflation and the index of investors’ fear VIX. As I mentioned above, I took data from Google Trends that show interest in both terms and topics. Then I took the logs of the data to normalize all metrics. The Pearson correlation tests show that the correlation has strengthened during the last seven days, suggesting there might be symptoms of Contagious effect. The over the year Person correlation coefficient is approximate to .49, which is indicative of a medium positive correlation. The over the week Person correlation test showed a stronger correlation coefficient of .74 which is indicative of a stronger correlation. Both p-values support evidence to reject the null hypothesis.

The following is the results table:

February 1st – February 8th correlation (50 U.S. States):

February 2017 – February 2017 (50 U.S. States):

It is worth noting the sequence of the events that led to these series of blog posts. On January 31st, 2018 Alan Greenspan told Bloomberg News: “There are two bubbles: We have a stock market bubble, and we have a bond market bubble.” And, on February 5th, 2018, Dow Jones index falls 1,175 points after the trading day on Monday. As of the afternoon of Friday 9th, the Dow still struggle to recover, and it is considered to be in correction territory.

Recent Narratives of Stock and Bond Bubbles.

On February 5th, 2018, Dow Jones index fell 1,175 points after the trading day. Four economic scenarios are being analyzed in the news as of the first week of February 2018. First, there are indeed both Stock Market and bonds Bubbles. Second, the Monday Dow’s selloff is just an anticipated correction move on the investor’s side. Third, the stock market returns to the old normal of higher levels of volatility. Fourth, Trump economic effect. I need not to cover the concerns on the US economy nowadays in this blog post. Hence, the analysis that I think is needed currently is the ruling out of a contagious effect from the narratives created around the Dow’s selloff on Monday. Indeed, I believe that such narrative, if any, can be traced back to former chairman Alan Greenspan’s comments when he stated on January 31st that America has both a bond market and stock market bubbles. By discarding the contagious effect in current narratives, I side with analysts who have asserted that the Dow’s fall was just an anticipated market correction.

Can economists claim there is some association between Alan Greenspan’s comments and the Monday fall of the Dow Jones? I may not have an answer for that question yet, but We can look into the dynamics of the phenomenon to better understand how narratives could either deter or foster an economic crisis in early 2018. If there is room for arguing that Mr. Greenspan’s comments triggered the Dow Selloff on Monday, I believe we should be observing some sort of panic or manifestation of economic anxiety. By looking at data from Google Trends, I spot on breakouts that may well be understood as “spreading” symptoms. In other words, if there is any effect of Mr. Greenspan’s comments on the Dow’s selloff on Monday, we should expect to see an increase in Google searches for two terms: first “Alan Greenspan”, and second “Stock Market Bubble.” The chart below shows google trends indexes for both terms. Little to nothing can be said about the graph after a visual inspection of the data. It is hard to believe that there are narratives of economic crisis fast-spreading, nor have Mr. Greenspan’s comments had any effect on the Dow’s sell-off.

How did things occur?

Economists are lagging on the study of narratives, hence the limited set of appropriate analytics tools. Robert Shiller wrote early in 2017 that “we cannot easily prove that any association between changing narratives and economic outcomes is not all reverse causality, from outcomes to the narratives,” which is certainly accurate whenever time has passed as empirical evidence become obscure. However, on February 1st of 2018 mainstream media reported extensively a couple of statements made by Alan Greenspan about bubbles. In the following two days, several market indexes closed with relatively big loses. In detail, the events occurred as follows:

  1. On January 31st, 2018 Alan Greenspan told Bloomberg News: “There are two bubbles: We have a stock market bubble, and we have a bond market bubble.”
  2. On February 5th, 2018, Dow Jones index falls 1,175 point after the trading day on Monday.

Whenever these events happen, we all rush to think about Robert Shiller. As Paul Krugman cited Shiller today February 6th, 2018, “when stocks crashed in 1987, the economist Robert Shiller carried out a real-time survey of investor motivations; it turned out that the crash was essentially a pure self-fulfilling panic. People weren’t selling because some news item caused them to revise their views about stock values; they sold because they saw that other people were selling”. In other words, Robert Shiller’s work on Narrative Economics is meant for these types of conjectures. Narratives of economic crisis play a critical role in dispersing fear whenever economic bubbles are about to burst. One way to gauge the extent to which such a contagious effect occurs is by looking at google trend search levels.

 

 

No signs of fast-spreading economic crisis narratives:

Despite the ample airtime coverage, there is little to none evidence of a market crash and economic crisis. In the wave of fast pace breaking news announcing crisis and linking them to political personalities, markets seem just to be having an expected correction after an extended period of gains. The best way to conclude such correction is by looking at the firm numbers reported lately on jobs markets as well as to investigate the collective reaction to fear and expectations. Thus, four economic scenarios are being analyzed as of the first week of February. First, there are Stock Market and bonds Bubbles. Second, the Monday Dow’s selloff is just an anticipated correction move on the investor’s side. Third, the market returns to the old normal of higher levels of volatility. Fourth, Trump effect. None of the scenarios seem plausible to me. First, the selloff appears not to have dug into the investors and people’s minds, thereby avoiding the contagious effect. Second, despite the unreliability of winter economic statistics, jobs reports on January 2018 seem optimistic (I think they will revise those number low). Third, claiming volatility is back to the stock market is like claiming Trump is back into controversy. Therefore, the only option left to explain Monday’s selloff is the argument of a market correction.