Wall Street has a wonderful sense of humour. Its favourite joke is the one about how it is highly rational.
This is true only if you define “rational” as meaning adept at rationalizing. Yep, Wall Street does shine at that.
Consider the current situation: Donald Trump has declared a global tariff war. He has publicly trashed his country’s 80-year-old commitment to defending Europe. He has embraced Russia’s thuggish Vladimir Putin and fired many of the Pentagon’s top generals, while simultaneously declaring his desire to annex Greenland and Canada.
These manoeuvres would seem to be—choose your preferred term here—alarming? Disastrous? World-changing?
Not according to Wall Street. Despite recent sputters, the S&P 500 index remains near record highs. Despite Trump’s threat to Canada’s standalone existence, so does Canada’s S&P/TSX composite index.
For its part, the bond market seems nearly bored by Trump’s eagerness to fracture the global trading system and subvert the principles that have guided U.S. foreign policy since the Second World War. Credit spreads on high-yield corporate bonds, which normally balloon during times of crisis, remain at some of their narrowest levels in decades.
Pollyanna would be proud. According to financial markets, the message is clear: There is nothing to see here. Move along.
If this strikes you as being willfully blind, join the club. But the market’s amazing indifference to current events raises an interesting question: Why are investors being so complacent?
The simplest explanation is that Wall Street thinks Trump’s policies could actually be good for the economy and for the United States. After all, he is likely to cut taxes and slash red tape, isn’t he? Surely, that must be a plus!
Um, maybe. But judging from the daily flood of research reports, many people on Wall Street are clear-eyed about the dangers the president is courting. Most economists regard his tariff threats as somewhere between silly and downright hazardous. Most strategists are also nervous about the size of Washington’s gaping deficit and Trump’s apparent willingness to expand the already huge budget gap even further.
Euphoria over artificial intelligence may be helping to offset the anxiety. Many Wall Street analysts have convinced themselves that AI will open up huge new opportunities, and that could be allaying nervousness about what is happening in other areas.
Still, it’s hard to see how AI could be supporting the market by itself. It has yet to produce anything in the way of profits. No matter how optimistic about AI you might be, it seems radically premature to assume that we will derive a gusher of benefits from a technology that to date has been nothing but a huge money pit.
So that brings us to what may be the most robust explanation for Wall Street’s apparent indifference to growing geopolitical chaos. It could be that financial markets simply can’t comprehend a shift this big and this rare.
Complacency is the rule, not the exception, on Wall Street.
Wall Street analysts perform best when they’re estimating the impact of events that recur regularly. They can look back at history, compare the latest reading to previous readings and gauge the probability of various outcomes based on a long track record of similar experiences.
It’s a process that works well if you’re assessing a quarterly earnings report or an annual inflation reading. It doesn’t work at all if you’re trying to get a handle on a once-in-a-lifetime phenomenon.
This cognitive glitch helps to explain why Wall Street is so bad at spotting major turning points. Back in 2007 and early 2008, investors ignored mounting signs of trouble before the collapse of Lehman Brothers in September 2008 shocked them into reality. The S&P 500 then lost half its value in three weeks.
Similarly, the S&P 500 was rising steadily in the first few weeks of 2020 despite reports of a strange flu-like disease spreading from Asia. It was only in mid-February 2020 that markets finally recognized the COVID-19 threat and the index collapsed.
Complacency is the rule, not the exception, on Wall Street. The market’s bedrock assumption is that short-term disturbances will fade and that trends will revert to the mean. Its optimism is based in large part on confidence that the government, central banks and regulators will do everything they can to restore order.
That assumption becomes questionable when it is the government itself that is propagating chaos. Investors may want to keep this in mind as they contemplate Trump’s spreading wave of damage. His strategy of attacking allies, breaking deals, rewriting history and cozying up to people like Putin and China’s Xi Jinping is difficult to understand, unless you accept Gideon Rachman’s recent diagnosis in the Financial Times and conclude that Trump’s real goal is to make the world safe for autocracy.
Investors should be aware of the dangers. They should not assume that lofty stock markets and comatose bond markets amount to an endorsement of what is happening. That complacency is just Wall Street doing the usual Wall Street shtick. Don’t be surprised if its routine soon changes.
Ian McGugan writes about markets and economics. His work has appeared in the Globe and Mail, the New York Times and Bloomberg/BusinessWeek. He was founding editor of MoneySense magazine.
The Canadian Family Offices newsletter comes out on Sundays and Wednesdays. If you are interested in stories about Canadian enterprising families, family offices and the professionals who work with them, but like your content aggregated, you can sign up for our free newsletter here.
Please visit here to see information about our standards of journalistic excellence.