Most of us have little understanding of what makes equity markets move in one direction or another.
A long time ago, one of my professors explained to me: “It’s 5 percent fundamentals; the rest is determined by however big investors feel when they wake up in the morning.”
What about the experts? Well, according to Adena Friedman, president and chief operating officer of Nasdaq Inc.,
“Once emotion comes out of the market, fundamentals should prevail.”
Really, in markets that are by their very nature speculative, how can one distinguish between emotions and fundamentals?!
Unfortunately, the interviewer never followed up by asking Friedman to explain what the so-called fundamentals are and how she would know when those fundamentals, not emotions, are driving stock markets.
Mainstream economists tend to be fervent believers in markets. They celebrate markets: they argue they should be free of intervention when they exist, and that they should be created when they don’t. Basically, they believe, markets are efficient institutions, populated by rational actors, which maximize individual and social welfare
But something different happens when it comes to equity markets, especially when they are declining, such as the past few weeks. Markets are no longer efficient, reflecting the “fundamentals,” and actors are no longer rational, but are instead guided by something else, “emotion.”
Here’s one such mainstream economics, Alan S. Blinder:
In sum, the traders who make stock market prices seem to have a few things wrong: China is not as big a deal to us as they think; and falling oil prices should help, not hurt, U.S. growth. Don’t misinterpret any of this as investment advice, however. The market can stay irrational longer than you can stay solvent.