Investors often freak out when they see negative news on TV, wondering what it means for their stock portfolio. Similarly, they often rejoice when good news comes out, thinking stock prices will soar. But stocks don’t always respond to news the way you might think. They’re much more nuanced than that.
In a recent article on CNBC, Josh Brown states[i]:
Each day, investors are treated to news about the economy and information about how the stock market has done recently. It can be very difficult to process what’s going on because at any given moment in time, there may be very little correlation between how things are going in the real world and how prices are acting on Wall Street.
This is because investors are more concerned about how recent news will affect the future. They’re looking at the likely future chain of events based on what is coming out on the news right now. For example, news might come out that “Unemployment hits an all-time low,” and then the stock market drops right after. Why? Because this news might set off a negative chain of events for the stock market.
The News Snowball
Low unemployment might mean there is a shortage of labor in the economy. With more jobs available than there are job candidates, wages could rise. If wages rise, company expenses go up, which means profits go down, leading to increased inflation. Higher inflation can lead to higher interest rates and eventually an economic slowdown.
There’s a near-infinite number of variables that affect how the market responds to the latest news, and no one person could process all that information at once. However, all the investors across the world, each with a small piece of the puzzle, combine their knowledge to process all these variables almost instantly.
If you look at a stock chart over a short period of time, you’ll see a completely random zig-zag line. It darts up one second and plummets the next. Investors can drive themselves mad staring at these charts and trying to predict what comes next, all the while hovering their finger nervously over the “sell” button, What if the market drops and I lose everything? Can I get out of stocks quickly enough?
There’s a better way.
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Josh Brown cites[i]:
The noted fund manager and author Ralph Wagner once described the relationship between the economy and the stock market like this:
There’s an excitable dog on a very long leash in New York City, darting randomly in every direction. The dog’s owner is walking from Columbus Circle, through Central Park, to the Metropolitan Museum. At any one moment, there is no predicting which way the pooch will lurch.
Typically, the economy trudges along a straight path for years at a time[,] and it’s the stock market that is easily excitable, ripping to and fro based on the latest information to hit the tape.
I often talk about how optimism is the most realistic way to approach life. Consider Wagner’s dog-walking analogy.
The Stock Market and Dog-Walking
When I invest, I’m temporarily saying “I don’t need this money right now, so I’m going to let someone else use it—companies, governments, whoever. Since they’re using my money, I should be compensated, so I’ll charge interest or require a share of the earnings in whatever I own.” The folks that run these companies—the ones using my money—are the dog-walkers. These people—CEOs, managers, and shareholders—all have the same goal: MAKE THE COMPANY PROFITABLE. Even the government—though it doesn’t always look like it—wants this because if there were no company profits, then there would be no taxes and no jobs.
When there’s a lull in profits, these people go into high gear looking for any way to get back into the green. They keep working until the company is profitable again, whether that means cutting expenses, changing strategies, or selling something that people want.
We all want our lives to get better, and so we keep moving forward, finding ways to improve. Companies are no different. They continue to march “Northeast,” and as they do, the dog—stock prices—will follow. It may be erratic, dashing from trashcan to squirrel, but over time it stays in the direction of its owner. An observer focused solely on the dog will worry himself with where it’s going, but the observer who steps back to see the dog in context with its owner doesn’t have to wonder about where the dog is headed.
What It Means for Downturns
I just don’t sweat downturns. I have confidence in where society and the economy are headed—the same way both always have been. What makes me sweat is when I see investors lose their discipline because they fear what the market will do. I sweat because I’ve seen so many investors lose hard-earned savings when they could have avoided it by just holding on a little longer.
It’s time to relax and take the dog for a walk.
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Written by Paul Winkler
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