Some are still scratching their heads at the low levels the stock market is trading at…
The current corporate results should have propelled stocks much higher, still they correspond to the time interval when stock prices fell most sharply. To argue that good company news are good for the stock market could at the minimum attempt to presuppose a time lag of days. But we are now a few weeks after the fact and there is no bounce.
Some will try to say that stock markets are not acting very logically due to automated trading. However, it is difficult to believe that they were related only to “trend watching” and not to larger and deeper issues, including such things as lack of rational behavioral reactions that underpin the performance of stocks. Whatever their ultimate cause, the current drops in stock prices are indicative of unstable market psychology, not due to dysfunctional computer based algorithms.
Still, they don’t like to focus on market psychology. After all, doing so implies that price movements are less predictable (and analysts/money managers less omniscient) than they like to imagine. But such a focus makes intuitive sense. What really matters is what’s on investors’ minds. There is now more than ever a greater focus on the new branch of finance, known as behavioral finance, which essentially recognizes the "humanness" of market participants that adversely affects their decision-making (as opposed to standard finance that assumes a "rational" investor).
One of the results of Behavioral Finance is market liquidity. This is the new anomaly we are witnessing: the stock market, previously relatively illiquid, gains some attention on some realization that the economy has weakened. Stocks drop on pessimism about the weakness of its prospects, and traders sell. As volume picks up, stocks break past all support levels, attracting technical traders. The momentum carries it on day after day. Stocks retrace all the way back to where it came from and soon becomes less news worthy again as a new wave of market favorites take over. Liquidity dries away again leaving the stock market to the effects of gravity.
The swings of market liquidity, sometimes unrelated to intrinsic company-specific fundamentals but nearly always linked to sudden market-wide realization of pessimistic views, is another reversion-to-mean effect that is often difficult to reverse unless you are able to create upward momentum through confidence.
The market bottom will strangely come on a day when bad news comes out and stocks do not react. Classic “sell on rumor, buy on news.” All you need is this bounce, and as with any other prices in financial markets, once there is a price increase it will attract attention. When stock prices will start rising quickly, people will pay attention to the related news and talk to each other more about the stock market, hence creating heightened sensitivity to the news thus, sustaining momentum.
Yes, it is. If one believes that the market is efficient all the time, then perhaps it's not a change in sentiment/perception that is in play here. I clearly don't believe in the Efficient Market Theory and this is what I have been writing about here.
Behavioral finance has helped me identify the flaws in such an assumption. I believe that price movements are due to human psychological tendencies that distort rational behavior and especially in extreme times like these, tendencies can be exacerbated either by rapidly falling prices or even rumors that might have seemed absurd in more normal times. Left unchecked, this instability could develop and feed on itself; perception becomes fundamentals which further reinforces perception.
That, incidentally, has been my belief since 2003, when I first started posting on this board.
If the above intrigues and interests you, you should read Tom's Market Weekly Commentary at OPCO's website, where I find it. I am sure you will thoroughly enjoy today's comments, as I did. I can feel myself nodding in agreement with many of his views; they are after all what I have come to accept over years of analyzing the stock market.