Feb 2018 Comments: The Difficulty of Attributing Causation to Stock Price Movements

Sam Ngooi Comments

This month’s Comments provide current examples of an important point we have made regularly in the past: no one really knows the causes for stock prices and their sometimes dramatic changes.

Current case in point: from Friday, February 2nd through Thursday, February 8th, covering only five business days, US stock prices (S&P 500), declined by approximately 9% (2,832 to 2,581, a 251 point decline).  The reason given by the media, and other nominal experts, was that likely coming inflation and accompanying higher interest rates were bad news for stock prices (we know they are bad news in the short run for bond prices as well).

But then what happened from February 9th to 14th, over four business days? The S&P 500 regained approximately 4.5% (2,581 to 2,699, a gain of 118 points), even as the economic reports continued to show higher inflation and higher interest rates (along with continuing lower bond prices).

How can stock prices decline in one week, and gain in another week, with the same stated reason for the price changes?  Since that is not logically consistent, there must be some flaw in presenting the cause in the first instance. Our view at Park Piedmont is that causation of stock price changes is extremely difficult to pinpoint, and even when there is widespread agreement as to a reason, the conventional wisdom is often wrong.

A second, more recent example covered four business days between February 28th and March 5th. On the 28th, President Trump announced, surprisingly, the imposition of tariffs, going against most conventional economists who typically oppose tariffs. Stocks proceeded to fall approximately 1.5% (2,714 to 2,678 on the S&P 500), and the media and other pundits were sure tariffs were to blame. Three days later, stock prices were higher (at 2,721) than the day before the decline, and tariffs were still to be imposed.  Then Trump’s economic adviser Gary Cohn resigned over the tariffs on March 6th, and the pundits predicted serious declines due to that event. But there were no declines at all. Events that the media claim as causation for falling stock prices are often incorrect. And, at times, the predicted events do not even occur.

To show this is a common occurrence in media reporting, remember back to Trump’s most surprising election victory, and our Comments (October 2016) at that time:

An excellent example of the “herd mentality” related to the certainty of significant declines appeared in the NY Times on election day (11/8/16, page B1), in an article titled, “What the Election’s Results Will Mean for the Markets,” by highly respected financial columnist Neil Irwin. The article begins: “What will happen to financial markets after the election? More so than usual, we have a decent idea. That’s because there has been a clear and identifiable swing in a variety of asset prices – especially the stock market and currencies – at inflection points in the presidential race. A stock market rally on Monday is the latest evidence, and appears to be linked to the FBI announcement that an examination of newly discovered emails tied to Hillary Clinton revealed nothing warranting charges.”

And in a post-election NY Times article (11/11/16, page B1), James Stewart, another well-respected financial columnist, wrote: “To the long list of pundits who called the election all wrong – as well as its consequences – add Wall Street analysts.” He cites predictions of 11-13% declines, and 2,000 points on the Dow (approximately 11%), and observes that “with the benefit of hindsight, what’s extraordinary is how few professional investors saw it coming. Trump was derided as the candidate of uncertainty, which markets typically abhor…. But there was nothing uncertain about his overall pro-growth, pro-business and American-first tendencies, now backed by the firepower of a Republican House and Senate.”

To us at Park Piedmont, this simply reinforces the absolute futility of making predictions. This is not to pick on Mr. Irwin or the NY Times; it’s simply to illustrate, once again, the real problem that we as consumers of financial information face. We are unable to distinguish between what does and does not make sense, even in well-written articles by presumed experts.

Reviewing some of the key points we made in our March 2017 Comments, we reiterate the following:

  • The factors that move stock prices are many and varied. In our view, there is no way to explain day-to-day stock price movements with any one or two explanation points (e.g., Trump’s economic legislation agenda under attack). If that’s the case, then why does the media find it necessary to report on the markets as though they were a single sporting event, providing an often incoherent narrative (e.g., a slow trading day suggests that portfolio managers acted earlier in the week)?
  • There is no way a Times reporter – or any reporter, for that matter – can accurately “know” what “investors” are thinking, and what makes them act, and report as if the claim is accurate. The results of any day’s stock price movements are the results of the activity (and inactivity) of many thousands of market participants – professional and amateur, traders and long-term investors. Who could possibly know what ideas are moving each of them to do what they do each day, let alone report on the “market” as though it’s an independent entity with its own intentions?
  • It’s also hard to understand how the media can report that one day such-and-such-a-factor caused the market to move in one direction, and the next day, when prices move in the opposite direction, report that investors ignored the factor so essential the day before.
  • Bad news is almost always emphasized, which tends to make people nervous and more likely to change their investments, rather than act as long-term investors with a time horizon of years, not minutes. Bad news may sell more newspapers, but emphasizing bad news can lead to adverse results by suggesting to investors they should take action in light of the news, rather than taking the longer-term view. Much of the investment literature supports the view that the fewer changes made to a portfolio based on reacting to current news items, the better the long-term outcome.
  • Market reporters feel the need to infuse an article about market activity with explanations. Humans like stories; we at PPA are no exceptions! But rather than report the reality, which is that prices change day-to-day for many reasons, none of which are clearly or independently verifiable, at least most of the time, a narrative develops as an after-the-fact explanation of events.
  • In the long term, economic growth rates and corporate earnings are the most important drivers of stock prices (mentioned ever so briefly in some of the daily reporting above). They are not a day-to-day story, however, and are difficult to capture in daily reporting. Instead, they play out over extended time frames, which aligns with the preferred, longer-term timeframe for most investment portfolios.

In sum: try to ignore most of the media’s day-to-day reporting on market activity, as it is likely to lead to thoughts of making (typically unnecessary) changes, and therefore unlikely to benefit your long-term investment results.