Nobody understands the stock market

When the market plunged last week analysts had their excuses ready. The truth is nobody understands stock market movements.

In the film Being John Malkovich, there’s a small door hidden behind a filing cabinet in a New York office building.

If someone crawls through the opening, that person temporarily enters the mind of actor John Malkovich.

The clerk who stumbles upon this bizarre discovery makes a business out of it. He rents out this portal for $200 a pop.

I’m secretly hoping a similar door exists that gives access to the mind of Donald Trump.

Maybe then I’ll understand why he takes credit for things he has no influence on, like the fact that there were no commercial airline deaths in 2017.

The US President has also tied a rising stock market to his administration on many occasions…

But when the market suddenly drops, it’s obviously someone else’s fault.

A week ago the Dow Jones Industrial Average fell more than 800 points. It was the biggest single-day drop since an unholy day in February shaved 1,000 points off the market.

Trump blamed the “crazy” Fed for hiking interest rates too fast. Not even Trump predicted the market plunge before it happened, though.

Why do we pretend we can understand the markets when not even the most brilliant minds on the planet can?

Frankenstein’s monster

Last week’s market tumble prompted Nobel Prize winning economist Paul Krugman to have a conversation with himself on Twitter.

“Why did the market suddenly plunge? I have no idea.

“Will it keep going down, or bounce back? I have no idea.

“Is this going to translate into problems for the real economy? I have no idea.

“But what you need to know is: nobody else has any idea, either.”

This speaks volumes. If Nobel winners can’t predict market moves, how are mere mortals supposed to know what’s coming?

Let’s face it – nobody can predict stock market moves in advance.

And if we’re really honest with ourselves – for sometimes we must – we’re not even good at pinpointing exactly what caused a market drop after the fact.

Trouble is, we pay people to predict these phenomena even if we should know better…

Thousands of years into human civilisation, psychics can still make a living. And a thousand years from now, people will still expect analysts to predict the market’s future.

After all, this is about our money. We’d like to at least pretend we have some kind of control.

If we surrendered ourselves to the notion that markets move in a completely random pattern, no one would think it possible to “buy low, sell high”.

Who would still dare to invest in this out of control Frankenstein monster of our own making?

And so market watchers did their best to churn out credible explanations for last week’s 3% fall in the stock market.

Some of them agreed with Trump that the “loco” Federal Reserve was raising interest rates much faster than they ought to.

Others saw the sky-high valuations in the US stock market as a reason why investors cashed out in droves.

Or perhaps it was Trump’s trade war with China that was to blame. The dollar’s too strong and tariffs are hitting exports, which has now taken its toll.

You see? There are plenty of theories to explain the by now obvious and inevitable market drop that took place last Wednesday.

Crisis averted.

The random walk theory

Since we’re really honest with ourselves today, we have to admit that none of these explanations are truly satisfying.

The Fed tightening monetary policy by lifting interest rates may have been a contributing factor. However, we’ve known that US central banks have been on this path for a while.

In September Fed chair Jerome Powell announced the third rate hike this year. Why did it trigger a reaction weeks later and not sooner?

Why didn’t the market react after the first rate increase in March? Why did the market shoot higher after the second hike in June?

What about those ultra-high stock market valuations? The Wall Street Bull has gone berserk – stocks were bound a correction.

Nobody’s arguing that. But it doesn’t explain why the market fell last Wednesday (and not a day sooner, or later) and why no one had the foresight to tell us it would happen.

And finally there’s the trade war hypothesis.

China was the piñata Trump hit on every campaign rally. He’d threatened the country with trade war on many an occasion.

But even when Trump suited the action to the word in February the market kept rising.

Why the trade war troubled Wall Street all of a sudden on 10 October 2018 after months of indifference no one can say.

Maybe that’s because we secretly all know that trying to understand the market is like trying to see a pattern in the random walking of a drunk.

Unlike a sober person who moves in a steady, straightforward way, drunks tend to lose their balance a lot. A drunk randomly swings to the left and right.

The “random walk theory” says that stock prices don’t follow any pattern, which means past trends can’t be used to predict future movements.

“The random walk thesis of how markets move is the best explanation we have,” admits Bloomberg columnist Barry Ritholtz.

“The alternative is looking at these events retrospectively, and from that vantage point they all seem so blindingly obvious.

“But if they were so obvious, why didn’t we see them coming?”

Conclusion: Nobody understands stock market movements because there is nothing to understand.

Not even Nobel Prize winner Paul Krugman has any idea why markets move the way they do.

I do have a helpful tip from another Nobel laureate, Richard Thaler, for everyone who’s got money invested in the stock market:

“Scrupulously avoid reading anything in the newspaper aside from the sports section.”

1 Comment
  1. JK 2 years ago

    Eh, Krugman didn’t win a Nobel prize. He won the the Swedish Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, for “his analysis of trade patterns and location of economic activity” – presumably working out that trade is correlated with economic activity, or other such rocket science, but nothing to do with stock markets. And he won it in 2008, the year stock markets and the financial system were crashing all around him, yet he and his genre didn’t manage to foresee it, nor even to spot it as it was happening right in front of them.
    Of course, they could all tell you with certainty afterwards what happened – thanks for that – and put forward theories about what to do about it (let me think: print lots of money, and hand it out to the people who caused the problem).
    One day, we’ll look back and wonder why we placed any faith whatsoever in these charlatans known as ‘economists’: future generations will wheel them out and run the old videos just for comedy purposes.

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