Conventional wisdom holds that stock and bond market prices reflect investors’ expectations about the future.  This is one of the key arguments against market timing:  not only does your view of what’s going to happen have to be right, it has to different from the consensus because that’s already priced into the market.

For example, if you think rising interest rates will damage stock market prices, and therefore you should sell or reduce your stock holdings, it’s not enough to be correct, your expectation must also differ from that of most other investors.

As the great British economist John Maynard Keynes put it, “Successful investing is anticipating the anticipation of others.”

But do the markets always fully discount investors’ collective expectations?

No, they do not.

Several academics, including Barry Eichengreen at the University of California, Berkeley, have shown that even very significant events, fully anticipated by investors, are not necessarily discounted in advance.  This occurs when the timing of such an event is highly indeterminate and the outcome uncertain.  For example, everyone expects the Federal Reserve to raise interest rates sometime.  But when?  Maybe a year from now?  Maybe two? That’s too vague and too far away for markets to worry about today.  If the expectation were for higher rates in three or four months, that would be a different story.

This is why Mr. Bernanke’s remarks about tapering the Fed’s bond market purchases caused sudden panic this spring.  Everyone already knew the Fed couldn’t keep buying $85 billion a month of Treasury and mortgage-backed bonds forever.  But until Mr. Bernanke made his remarks, the consensus expectation was that this program would persist for now.  When the end of “now” suddenly seemed imminent (i.e., perhaps within six months), only then did the markets discount the likely outcome by rapidly unloading bonds, pushing yields higher.

This reaction is probably a dress rehearsal for the main event.  Aggressive monetary policy prevented a full-scale depression, juiced the stock market, and drove interest rates to unprecedented lows.  So the financial markets have feasted on it, even though recovery in the real economy has proved anemic.

But as Michael Gerson recently wrote in The Washington Post, Mr. Bernanke’s successor “will test whether easy money has been a caffeine high or a heroin high, with the consequences of withdrawal ranging from unpleasant to debilitating.”  Investors know this full well, but they don’t know when the spiked punch bowl will be withdrawn and they don’t know how bad their subsequent hangover will hurt.

For this reason, what happens on the other side of quantitative easing has not been fully discounted by the markets.  As long as money remains cheap and abundant, with no clear sign that’s going to change in the next few months, carpe diem is the order of the day.

My advice?  Be cautious.  Party like there is a tomorrow and you want to get there in good financial health.  Don’t assume a stronger economy will mean higher stock prices—there’s very little correlation between the two.  And don’t forget that as stock prices rise, so does your exposure to risk.