Hello Consumerism Commentary visitors! I’m glad I was able to write a guest post for Flexo. I’d be even more happy if you came by on your own! Here are a few reasons why you should:
1. This ain’t your typical personal finance blog. I don’t often tackle the basics of a Roth IRA or how to choose a money market account. I do write about the cutting edge of behavioral finance and how it should affect the choices you make.
2. I won’t overload your inbox or feed reader with posts. I only post two or three times a week, but I try to swing for the fences with every one. That might be part of the reason I’ve been an editor’s pick in five carnivals of personal finance, despite only being around for a couple months.
3. I have cool art. There’s more than one reason it’s called Pop Economics. So please subscribe!
She’ll give you the news but she won’t make you money.
The news anchor above is good for many things. She’s a whipsmart interviewer. She’s a rapid purveyor of new information. She might even be an accurate analyst of the implications of current events. But there’s one thing she, and the other anchors who accompany her, are not good at: Making you money.
The big healthcare bill passed last Sunday, and Barack Obama signed it into law on Tuesday. And you know that already, unless you’ve been living under a stethoscope. Stuff like this spawns lots of stories on how to make money off the new law. A lot of pundits predicted its passage would tank the stock market, or at least deal a blow to some companies in the medical or insurance industries. But lo and behold, on the day after Congress gave the O.K. the stock market…did…nothing. Skeptics say that’s because most of the law won’t take affect for a few years. Supporters say it’s because the whole “end of capitalism” schtick was B.S.
Truth is, they’re both wrong. And it’s not because someone’s right or wrong about the healthcare law—no, I have no idea what the answer to that is. Instead, both parties are making the all-to-common error of attributing market movements to a specific cause. So while the nice, pretty lady above might be great at telling you the news of the day, she’s not so good at telling you why the market did this or that.
The stock market is not of one mind.
This point might seem obvious, but the market is a collection of millions of investors who all compete with each other to make money. So when the market ticks up a point, it’s the sum total of hundreds of thousands of decisions to buy and sell.
But in a struggle to make all news relevant, you probably read headlines like “Market up on consumer data”, as if most investors are responding to a single event. Guess what? If the market were down 7 points, instead of up 7 points, that headline would read: “Market down on consumer data” even if the consumer data were the same. Don’t confuse correlation with causation.
Sometimes you can be pretty confident of a single driving force behind a market move, like a terrorist attack or the collapse of a major investment bank. However, most of the time, and especially when a market movement is small, the single “reason” for the move you’re searching for doesn’t exist.
Investors sometimes sell for personal reasons.
Complicating matters is that investors aren’t always reacting to external forces, like a company earnings report or economic event. Sometimes—and maybe oftentimes—they’re buying or selling because of something internal that isn’t even reported in the news.
This happened on a large scale in the bond market in 2008 and the beginning of 2009. The prices of corporate and municipal bonds fell so low that it appeared investors thought the entire market was about to implode. What happened? As it turns out, hedge funds, some of the biggest holders of bonds, faced a cash crunch and were forced to unload much of their position all at once. In other words, their individual needs for cash drove the selling, not the outside forces that analysts tried to connect to the market movements.
I’m sure it’s easy for you to see how that might take place on a smaller scale. Even if stocks are at bargain-basement prices, retirees will have to sell some shares to pay for food and housing. Likewise, even if the market seems way overpriced, workers saving in a 401k will still buy shares.
The market is a forecasting machine, not a reacting machine.
But the main reason the market didn’t make a big move up or down after the bill passed was that it had priced the bill’s acceptance into the market already. Maybe investors couldn’t be 100% sure that the healthcare bill would pass, but they could be 90% sure or 80% sure, or so on. In the weeks leading up to the healthcare vote, they had already bought or sold healthcare and insurance stocks as political winds changed. By the time Congress moved to a vote, healthcare stocks had already moved about as much as they were going to.
One of the only times you can make money off a news event is when the market’s forecasting machine is broken. But good luck recognizing that on a consistent basis. You either have to a) Know something that the market doesn’t—hopefully, without breaking the law—or b) Not suffer from an emotional bias that the market as a whole does suffer from. And it’s incredibly hard not to get caught up in a mania.
So next time you tune into CNBC or Fox Business, listen closely to the events the newsmen report but take their analysis of why the market moved with a few grains of salt. Truth is, no one really knows why.
{ 3 comments… read them below or add one }
I agree entirely with your main point, Pop. Most attempts to attribute stock price changes to a specific cause are exercises in gibberish. If stocks went up after signing of the health bill, people would have pointed to the signing of the bill as the cause. And if stocks went down after signing of the health bill, people would have pointed to the signing of the bill as the cause. When you use the same event to explain two opposite phenomena, you are talking nonsense.
I don’t think it is entirely right to describe the market as merely a forecasting machine. I think it would be better to describe the market as a machine that translates investor emotions into the numbers of stock prices. Our memory of how stocks were doing five years ago affect today’s price. So does our feeling about how the economy is going today. And so does our expectation of where things are headed in the future. The market translates numerous waves of emotion into a single current-day price. Today’s price reflects our feelings about yesterday, today and tomorrow.
It does indeed follow that you cannot profit by guessing how particular events are going to turn out. Where we differ (it seems to me) is in our take re how possible it is to predict long-term events. My view is that, as the years in which stock prices were moving strongly upward fade from more investor memories, there will be fewer positive emotion waves and more negative emotion waves influencing the current-day price.
I can’t say what specific event will cause prices to come down hard but I can predict with a reasonable level of confidence that we will indeed see prices come down hard as we move from the sets of emotion waves that dominated 10 years back into the sets of emotion waves we brought on ourselves by our failure to check our collective enthusiasm over those earlier emotion waves.
Reactions to specific events are not predictable. But general long-term trends are highly predictable (because the dominance of one type of emotion wave always creates the conditions needed for the dominance of the opposite type of emotion wave in the days following).
Rob
Rob, I agree, with one caveat – I think today’s price reflects the feelings of those who choose to participate in the market about yesterday, today and tomorrow.
Trading volumes are relatively low. Huge money has moved from the stock market to US government bonds. I think this indicates that today’s price reflects the optimism of those who choose to participate in the market. Large numbers of others who are less optimistic have chosen the perceived safety of bonds.
I think both stock and bondholders are in for an unhappy wakeup call.
I agree that it is impossible to attribute market movement to specific causes, but I don’t think the market is a forecasting machine. I think the market reflects the feelings of those who choose to participate in it.
Trading volumes are relatively low. Many of those who sold in last year’s fall have chosen to stay out. I think this means that today’s prices reflect the optimism of those who choose to participate in the market. Just because prices in the stock market continue to rise does not mean that general consumer sentiment is high.
Also, there is what I believe to be credible speculation that our government is propping up the market. Given the widely held idea in Washington and in academia that it is impossible for government to be in too much debt, this would not surprise me.