I was going to touch on China and the U.S. markets today, but something happened over the weekend that’s such a good illustration of the points I made on Friday that I have to talk about it first.

Saturday afternoon, my dad forwarded me an investment offer he had received from an oil and gas sponsor in Kentucky. They wanted to sell him a 1/64-of-1-percent interest in oil and gas wells there for $2,500, for which they believed he could receive a payout of about 90 percent of his initial investment in year one.

Per yesterday’s post, I want to start off by defining my terms. “Hedge fund,” for purposes of this discussion, means “currently fashionable investment that everyone wants because they think they will make a lot of money.” In this sense, “hedge fund” could mean housing in the mid-2000s, tech stocks in the late 1990s, commodities or the Nifty Fifty stocks in the 1970s, or—well, you get the idea.

At any given time, there will be a hot investment idea that is valid. (That’s probably how it got hot in the first place.) There will be well-established managers executing successfully in that space. They will understand the market, know what they’re doing and why, and will be very unhappy to see the rest of the world showing up in their niche.

One of the more, shall we say, interesting magazine covers showed up on my desk yesterday. Not, as you might expect, the Rolling Stone cover, which is simply a contemptible bid for publicity. No, I’m referring to the Bloomberg BusinessWeek cover, which displayed a somewhat graphic, at least on an implied basis, picture and graph.

The headline on the cover is “The Hedge Fund Myth,” and the cover story spends quite a bit of time excoriating hedge fund managers for making lots of money and not deserving it.

Over the past three months, we have seen quite a bit of volatility. What we’ve been talking about the past week or so has been downward volatility—the drop following the Fed meeting and Ben Bernanke’s press conference. This is what most people mean when they talk about market risk, and what upsets people.

Understandably so. I would argue, though, that the run we had from November up until late May—an almost uninterrupted ascent of the market indices—was also an example of volatility that should have worried us even more.

I speak regularly to groups of advisors and clients, and a question that has come up several times recently is whether the housing recovery can survive rising interest rates. In other words, as rates rise, will we see average housing prices level off or even start to decline again?

This is the last piece (for the moment) on the reemergence of price discovery in the market and what it means. We have talked about how market-based pricing of interest rates may affect the fixed income and stock markets, but what about other areas? And what about the wider effects of the retreat of central banks from economic manipulation?

There have been two big stories in the markets recently: rising interest rates and stock market volatility. I think these two themes are actually connected by a deeper factor—the reemergence of price discovery in the financial markets—and it is that we should be focusing on, as the underlying story will drive future developments.

Price discovery is the prime function of markets. The idea is that, in a free market with willing buyers and sellers, the price that emerges will reflect the actual, most economically efficient allocation of resources. When markets are not free, the price that emerges won’t necessarily result in economic efficiency.

— Guest post from Sean Fullerton, investment research analyst

Every so often, articles surface about the rising level of student loan debt and the risk it poses to the economy. The implication is often that the crisis brought on by excessive mortgage lending could be echoed by a similar crash in education-related debt. To examine these claims, let’s first look at some scary figures surrounding student loan debt.

What we were talking about yesterday was the “inside view” of the market. As defined by Daniel Kahneman, the inside view builds up from details and is based on inside knowledge of a situation. Detailed analysis is invaluable, of course, but details can often be used to support our initial biases rather than what’s actually happening.

It is also usually worthwhile to consider the “outside view,” where we simply examine what has happened in the past, without considering the details or why things might be different this time. This bigger-picture view limits the extent to which our biases can influence the conclusions.

Yesterday, we talked about why future economic growth may well be at lower levels than it has in the past. Today, I want to look at what that might mean for future stock market returns.

It’s important to note that we’re not talking about the absolute level of growth but the difference from historical levels. This matters because, if the future is different from the past, then metrics that are based on past performance—such as stock market valuation levels—may also be different.