Thursday, October 27, 2011

Fingers Crossed

The Dow Jones Industrial Average surged almost 340 points today on the news that European leaders brokered a deal that may avert, or at least forestall their own debt crisis.  Is the market's reaction to the news justified?

I have a theory about what the Dow, as well as all the other market indices, actually measure anymore.

In the long run, they always have been and still are fairly reliable measures of underlying economic reality.

But in the short run, it depends.  It depends on whether or not the economy is sound, fundamentally sound.  If it is, then the day-to-day swings in the market will remain relatively small.  But, if the economy is not sound, then the market will reflect that with wide and wild gyrations.  One day up 300 points, like today's Dow, tomorrow down a similar number, the next day steady as she goes.

There's really nothing new about this observation as market indicators have always been measures mostly of expectations, expectations about what actually is the state of the underlying economy.

What is new, and this is my theory, is that now market indicators include along with expectations an incalculable admixture of hope.  It's incalculable because hope is less rational than expectations.  It's possible to either per-suade or dis-suade someone about the reasonableness of their expectations with an appeal to a spreadsheet full of facts and figures.  Hope is different.

Hope has crept in alongside expectations over the last couple of generations as more and more common people have bought into the market through the advent of mutual funds and individual retirement plans of one sort or another.  For my father's generation, the stock market was something only rich or professional people had an interest in.  Today, by contrast, virtually everyone owns stock to one degree or another.

But while we own stock, we don't manage that interest in the same way rich or professional people of a generation and more ago did.  Instead, we just watch the market and, well, we hope.

Why has the market remained by any historical standard relatively high during these past few years of genuine economic turmoil?  Why does it leap at the chance to rebound on the slightest piece of good news, in this case, even news from across the Atlantic?

I think it is bouyed in large part by the presence of hope over expectations in a large number of investors.  No one wants to contemplate their future without a full and fat retirement account.  We've staked far too much on it and don't want to think too hard about what we will do if it comes up empty.  Unlike our forebears who quickly fled the banks when they got wind of bad economic news, we stay in the market come hell or high water and hope.

What else can we do?


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