During September 2021, the three major US stock indices declined between approximately 4.5% and 5.5%, with nine down days out of twenty-one total trading days. The financial media found it necessary to attribute causes to declines of this magnitude. But the frequent price increases in the midst of declines make the effort to attribute daily causation highly suspect.
What we have seen recently are stories that mention any or all of the following to explain the declines: (A) The US Federal Reserve getting ready to raise interest rates and gradually reduce its bond-buying program sooner than expected, which in turn reduces the extreme low interest rate support that the Fed has provided to the stock market since the start of the pandemic; (B) slowdown in the pace of economic growth, as the pandemic has lingered longer than anticipated; (C) negative impact of inflation, supply chain shortages, and labor supply shortages; (D) most recently, the possibility of US payment defaults, as Congress continues to debate raising the debt ceiling. While it is certainly possible that these factors can create plausible rationales for stock price declines, what does not make much sense are the days when prices rise even as the news remains equally negative. And perhaps even more importantly, how are investors (i.e., those committed to long term investing, trying to ignore the short-term fluctuations favored by traders) supposed to develop any idea of the amount and duration of the decline, when prices fluctuate up and down almost every day, for the same apparent reasons?
A recent example of the media’s treatment of this subject comes from The NY Times’ “Digest” section (NYT 9/29/21, pages B1 & B2), in an article titled “Concerns About Fed Cause Stocks to Tumble”. [PPA comment: note the word “Cause,” as if anyone/any entity can explain the reason(s) for a one day move in stock prices, when there so many potential factors impacting a countless number of market participants.] The article, in trying to explain a 2% decline for the S&P 500 index, states that “investors faced the expected wind-down of the enormous purchases the central bank has made since the start of the pandemic…. The trigger [PPA comment: note use of the word “trigger” as a synonym for the word “cause”] was a rise in the yield on the benchmark 10-year US Treasury note to its highest level since June, even though the Fed has said it does not plan to increase interest rates for months or years.” Further on the article states: “the Delta variant remains a concern for investors… [as do] rising prices… and the fight over raising the nation’s debt limit, a dispute that could lead to a government shutdown.” The problem with all this daily analysis is that, quite often, the very next day the media needs to find reasons for gains in stock prices (see NYT Digest sections (page 2) from 10/6-8/21). This generally means ignoring the problems/causes from the earlier article purporting to explain the declines, since the problems are still all with us.
We also point to an article (NYT, 10/4/21, page B1) by Matt Phillips, attempting to answer the question posed by the headline “What Next for Market After Drop?” “September saw the S&P 500 suffer its worst monthly drop since the start of the pandemic….in the face of a befuddling mix of signals about the next chapter of the pandemic recovery.” [PPA comment: note that “befuddling mix of signals” is another way to express the attempt to identify causes.] The article continues listing the current “usual suspects”: ”slowing growth, rising inflation, supply chain snarls, persistent threat of the coronavirus, brinksmanship in Washington, and the paring back by the Fed of its money printing programs that fueled the market’s rise over the last 18 months… All these issues have been simmering for months, but they didn’t seem to bother investors until late September, when the Fed signaled it was all but certain to start cutting back – or tapering – the $120 billion of new money it has been pouring into markets every month since the pandemic hit…. Of course, wild cards could turn the market around…”
Phillips is trying to use the recent issues confronting the markets to develop an analysis of what might occur in the future. At PPA we are confident of a few basic investing principles, one of which is that no one and no entity can consistently predict the future, any more than they can confidently attribute causation. After all, how could anyone know when investors would “begin to be bothered” by issues that have persisted for many months?
Robert Shiller (Sterling Professor of Economics at Yale, and best known for his thinking on the likelihood of the 2008 debt financial crisis) expressed his views on causation in trying to explain the current high prices for stocks, bonds and real estate (NYT 10/3/21 page B6). “What we are experiencing isn’t caused by any single objective factor. It may best be explained due to a confluence of popular narratives that have together led to higher prices. Whether these markets will continue to rise over the short run is impossible to say….and largely beyond our powers to predict…. There are many popular explanations for these prices, but not one in itself is adequate.” Shiller first discusses the impact of low interest rates, but says that while there is an element of truth to this, it is oversimplified. After all, the Fed has maintained low interest rates for years, following Stanford Professor John B. Taylor’s so-called simple stabilization rules. “In reality, most investors think in terms of contagious narratives that excite their imagination, not complex mathematical models, citing economist John Maynard Keynes that speculative prices are determined by intuitive guesses… arriving at a conventional basis for valuation for asset prices, and they accept it without much thought because everyone else seems to be accepting it.” Shiller goes on to warn that sooner or later, “the basis of these prices is likely to change violently as a result of a sudden fluctuation of opinion.”
Shiller continues: “Exactly when such changes will occur is the big question for investors. Unfortunately, economics provides few answers. One problem is that popular, superficially plausible theories are hard to stamp out, even if they are misguided. They keep coming back, purporting to predict the path of the stock or housing market (see also our May 2020 Comments, reviewing an important book about the life and times of Keynes). Shiller uses as an example a “tendency to think any apparent uptrend in speculative prices is a sign of economic strength that can be extrapolated indefinitely… This is an illusion…. Stories about the futility of trying to beat the markets… are generally not as lively as tales of an acquaintance making a killing on Robin Hood…. Timing is everything, yet it’s impossible to time the markets reliably. It would be prudent under these circumstances for investors to make sure their holdings are thoroughly diversified and to focus on less highly valued sectors within broad asset classes that are already highly priced.”
We would also like to highlight certain of Shiller’s ideas (see above) that we at PPA regularly comment on:
- He too is looking for some elements of causation: “confluence of popular narratives that have together led to higher prices.” As you can see in these September 2021 Comments, PPA is highly skeptical of this endeavor.
- Shiller also comments on the (in)ability to see the future: “whether these markets will continue to rise over the short term is impossible to say….and largely beyond our power to predict.” We would combine these two points, to be clear that what happens with short-term price changes are impossible to explain or to predict.
- He would like to get the timing right when market valuations change dramatically, but is he confusing traders with investors? At PPA we think this is a crucial distinction, as traders use stock market price volatility to buy and sell in very short time frames, trying to make gains as prices change. Investors in contrast buy and hold stocks for extended time periods, trying to benefit from the long- term anticipated growth of the world’s economies and have their money grow to meet personal long-term objectives.