Market Madness, Rampant Irrationality, & Animal Spirits: What Are Investors To Do?

On Tuesday's episode of Mad Money (after the Dow Jones Industrial Average closed up 102 points), Jim Cramer discussed the contradictory state of the markets that investors are currently facing. Cramer: "When we try to rationalize what the heck is going on by looking at all the various contradictory bets out there...well, frankly, we can only conclude one thing: Nobody knows what the heck they're doing! Irrationality is rampant!"

Several of the inconsistencies and trading contradictions that Cramer perceives in the markets today include the price of oil, the stabilization of the euro, the fact that European banks remain high despite financial problems, the price of gold, the stabilization of copper prices, and the fact that American companies doing business in European have not seen much weakness in the stock market. Cramer suggested that these inconsistencies are owing to the fact that hedge funds are making marginal contrarian bets that are distorting market prices. Cramer: "These different instruments from stocks to oil to gold to bonds, they just can't correlate like they should."

In light of the market's erratic behavior, Cramer suggested that there are no patterns right now that make sense in the market. Owing to the strong hold of hedge funds with gigantic bets, Cramer claimed that "the underdogs just keep winning because the line is being set wrongly each day".

In light of this market madness, Cramer claimed that investors may want to rely on "beautiful high-yielding stocks" until the market turmoil subsides. Cramer: "Irrationality is winning. We're seeing contradiction after contradiction. But at the end of the day, what defies the contradictions? Just high-yield. Everything else will look too crazy...even for this guy." High-yielding stocks that Cramer suggested for investors on Wednesday include Windstream WIN, Verizon VZ, Solar Capital, SLRC, Energy Transfer Partners ETP, American Electric Power AEP, and Sanofi SNY.

Though I agree with Cramer's analysis of the current state of the markets, I cannot help but feel that given the fragile state of the global economy, investors may find the safest refuge in metals including gold and silver. When everything else in the world seems to be soft, transient, and fleeting, holding on to that which is solid can be beneficial. (Heck, in this time period, even one investing in oneself via higher education can be suspect.) And in terms of assets, precious metals are some of the world's most solid -- especially with the prospects of rising inflation and another quantitative easing. Were the world economic situation to further deteriorate into a doomsday sort of situation where neither gold nor silver are viable assets, individuals can always look to more practical things -- like food, water, land...and soap. (In one way or another, by virtue of our physiology we cannot help but "invest" in food and water.)

Cramer noted on Tuesday that there may be some significant, ongoing market distortions and irrationality in the markets. Even so, on Wednesday reality appeared to set in as the Dow Jones Industrial Average fell nearly 400 points in the wake of problems in Europe. That being the case, one cannot help but feel that we are still waiting for the other shoe to fall from the European financial crisis. Just as it was starting to feel that the US economy was beginning to get back on its feet, financial turmoil in Europe seems to be taking a bite out of the global market -- including negatively affecting US markets.

Given drama in Greece and now Italy, things in the global economy appear to be intensifying. In the words of Marc Chandler, Brown Brothers Harriman chief currency strategist: "It's not just Italy. The contagion is spreading. They've got to stop this... All of this is showing rising tensions." Could things get worse? Is this just a temporary hit, or are more European dominoes going to fall?

In the wake of economic upheaval, German Chancellor Angela Merkel has said that, "It is time for a breakthrough to a new Europe. A community that says, regardless of what happens in the rest of the world, that it can never again change its ground rules, that community simply can't survive." Where the current financial crisis is proving to be quite a formidable test for the Eurozone, one cannot help but feel that as irrational and as crazy as things may seem in the global economy right now, perhaps we should have seen this all coming a long time ago.

Take, for instance, IMF managing director Christine Lagarde's claims that Europe's debt crisis risks plunging the global economy into "what some commentators are already calling the lost decade." That is old news for many economic analysts. As I wrote last July, the phrase "lost decade" may actually be a bit more optimistic than it sounds. We may actually be lucky if this global financial crisis results in a mere "lost decade". Given the intensifying gravity and perceived hopelessness of some of this planet's more serious issues, we will most likely be living with the effects of the current global financial crisis for some time to come.

The idea that we're running the risk of falling into a lost decade is far from new. While the markets may seem turbulent and crazy, is the current situation really that different from the recent past a handful of months ago? While individuals were once talking about Greece, now those same individuals are talking about Italy. Even if we look at the main headline for tonight's GOP debate, "GOP Debate: Weak Economy Takes Center Stage Tonight"...couldn't we have had the same headline for all the other previous GOP debates? From CNBC.com: "High unemployment, a teetering economy, and Europe on the brink sets a daunting backdrop for Wednesday's debate for a Republican presidential field without a clear leader." Yes, as much as things change, they remain the same. The economy is the issue, but life has to go on and money has to keep on moving despite global challenges.

In that light, I have to say that I strongly agree with Jim Cramer's analysis and commentary of the current market. Not merely because Jim Cramer is one of my personal heroes, but because I think he is correct. There does appear to be rampant irrationality. But tucked behind the perceived madness in the markets, there are yet glimpses of reality shining through. If we peer through the clouds of government intervention, massive hedge fund bets, high taxes, lackluster consumer confidence, political uncertainty, and various other market distortions, we should be able to see the true market at work. Individuals seeking to maintain and grow their wealth may want to rush towards safe havens and solid investments like arable land and precious metals.

In this way, Cramer's recent sentiments remind me of economist John Maynard Keynes idea of "animal spirits", i.e. emotions that affect human economic behavior. Keynes: "Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits -- a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities."

In other words, individuals move the market by virtue of Keynesian animal spirits and not by reason. Perhaps some of these animal spirits are to blame for perceived irrationality in the current global environment. The Economist notes that for Keynes, "animal spirits are a particular sort of confidence, 'naive optimism'", but could these animal spirits have a dark side as well -- a dark, pessimistic side that is at work in the markets today? As Keynes suggested, perhaps only time will tell what will become of the world's economic decisions of today. Perhaps after all the smoke has settled from the perceived rampant irrationality of today, rationality, clear market dynamics, and financial prowess in the global markets will manifest themselves. As economist Tim Harford discussed in the book "The Logic of Life", perhaps rationality can manifest itself in what appear to be the most irrational of circumstances and the most illogical of behaviors.

Even with rampant irrationality and animal spirits, life goes on and humanity manages to continue -- and with humanity, economic behavior. Whether that human economic behavior is rational or irrational may ultimately be a matter of perspective.


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