Imagine you’re from another solar system, and that you’ve come to Earth to study collective human behavior. Your task: the stock market. Millions of humans participate in it.
What will you learn by watching them invest their money into a collective pot?
Your first observation: Most human investors get information about the stock market from the mainstream financial news. Second observation: They seem to be glued to those news headlines and economic reports, trying to interpret what it all means for market trends.
So you decide to do the same. On the morning of October 8, you sit down in front of your super-advanced alien computer and check the economic news release calendar for the United States. Aha! 8:30 AM — the U.S unemployment report. It’s bad, and the DJIA futures are down before the trading even opens. Analysts say:
“U.S. stock futures stumbled deeper into negative territory Friday morning after the U.S. economy suffered deep job losses last month, as investors weighed the grim economic picture with the prospect of further action by the Federal Reserve to boost the economy.”
“That makes sense,” you think. “Of course stocks will fall today: The U.S. economy is so bad the government has to prop it up.”
Yet at 9:30 the Dow opens with an upward gap, trades higher for most of the day, and for the first time in months closes above 11,000. You scratch your other-worldly head and check the headlines for an explanation:
“Stocks rose Friday after another weak report on unemployment added to expectations that the Federal Reserve will step in to prop up the economy.”
“Wait a minute,” you think. “In the morning, they said stocks were down because the economy was so bad that the Fed would have to step in. But in the afternoon, after stocks rallied, the Fed’s intervention somehow became a bullish factor? Where is the logic in that?”
“Maybe it’s just a one-off,” you think. “Let’s keep observing.”
Exactly a week later, on October 15, you see the Dow up in early trading. All the major news outlets explain the rally essentially the same way: “Stocks rise as Bernanke reassures Fed ready to act.“
But then 4 PM rolls around the DJIA closes down. Again you look for explanations — and find this:
“…comments from Federal Reserve Chairman Ben Bernanke reinforced expectations for the central bank to move to prop up the economy, but prompted questions over how much stimulus has already been priced in.“
You start to feel like you’ve made an important discovery about collective human investor behavior. Wherever the stock market goes, there’s a news story “explaining” the move — often by using the same factors, whether prices go up or go down. You can’t help but say to yourself, “Don’t they see they are only chasing the market with those headlines and ‘explain’ the moves only after they happen? How can human economists insist on predictive value in those reports?”
At the end of the day, you sit down to outline your preliminary findings:
“Despite their rational capacity, the majority of human stock market investors seem to exhibit strong herding tendencies and a false understanding of causality. They are absolutely convinced that the stock market reacts negatively to bad economic news and positively to good news, but preliminary data clearly fail to support either premise. More study is needed.”
“If I invested like that on my planet,” you think as your super-advanced alien bed cuddles you to sleep, “I could never have afforded this trip.” The lights go dark inside the ship and you fall asleep. Tomorrow is another day of research.
Do your own “research” of the markets’ upcoming twists and turns by reading EWI’s latest forecasts online today, risk-free.
