Whenever we see any sort of disruption in markets an explanation usually follows. The headlines will explain that “Markets are going up/down because of this good/bad thing.” News anchors will solemnly intone why the volatility is significant and what it means for one thing or another.

None of these casual explanations can withstand close examination. They are often things that have existed for months or years, and so can’t account for what happened yesterday.

Stocks are fully valued, and have been for a while, so why is it that valuations suddenly matter after not mattering at all? The market for initial public offerings is too hot? Wait, the Federal Reserve is going to end quantitative easing, something it has been warning us about for two years? Now it suddenly matters?

Of course, all of these narratives serve a singular purpose: They give the appearance of meaning and rationality to actions that are meaningless and irrational. The daily action in the markets is a form of noisy, random, Brownian motion. If you are looking for a clear reason as to why stocks did what they did, then you are in the wrong line of business.

Given that truth, it was with great pleasure this morning I read a headline in the Wall Street Journal that accidentally reflected this reality: “Biotech Stocks’ Rout Perplexes Analysts.”

There are several things that make this such a wonderfully inadvertent truth-telling exercise. The headline implies that other times when stocks get shellacked, the analysts know and understand the reasons why. Never mind that they cannot forecast where these stocks will go, and all of their explanations are a post-hoc rationalization. But this time they are perplexed.

I find that delightful.

Here is the simple reality most of us try desperately to ignore: Most of the time, we have no idea what is going on. Our understanding of objective reality is at best tenuous. At its worst, our beliefs reflect a completely erroneous viewpoint, one that is as comforting as it is misleading. Indeed, the comfort often comes from hiding the truth from ourselves.

Consider this explanation of the artificial construct most of us live in: People create a happy little bubble of delusion. We engage in all sorts of cognitive foibles. Our selective perception allows us to only see that which agrees with our preconceived notions. Our selective retention only holds onto the stuff that confirms our views, disregarding the rest. In our minds’ eye, we are younger, better-looking, slimmer, and have more hair than an objective observer would see. The universe we construct bears only a passing resemblance to the objective world.

Sometimes, Toto pulls back the curtain and we see the wizard is nothing more than an old man with a few parlor tricks. For a brief moment, we understand how little we really understand. The grim reality of human cognition is that however little we know, we understand even less.

Hence, the accidental revelation in the headline is more noteworthy for how extraordinary it is.

Markets move up and down for no apparent reason. We have spilled plenty of ink and generated billions of pixels explaining why people want and need reasons to explain these movements. The human love of narrative is a dangerous cognitive failing that constantly leads investors astray.

As the ghost of famed trader @Jesse_Livermore tweeted, “People say the mkt will invent a reason as it falls — well, it hasn’t managed to invent one yet, despite extremely jittery price action…”

You can fabricate a story that makes you feel good. Or, you can face reality. Too many investors opt for comfort over truth. You can see it in their performance.


Originally published here


Category: Apprenticed Investor, Investing, Psychology

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

18 Responses to “Stop Looking for “the Story” Why Markets Are Falling”

  1. Orange14 says:

    BR – I spent my working career doing regulatory affairs in the pharmaceutical/biotechnology industry. Other than incidental holdings through a mutual fund I’ve never held a single share in a biotech company. 99% of them really don’t know what they are doing and will either disappear, merge, or live life as a Zombie company (no products but maybe a patent that is valuable to someone). The headline from the WSJ that you quote about analysts not understanding why the NASDAQ Biotech Index is down 5% is laughable. A good many of the companies listed on the Index are no better than penny stocks except they trade in the $single digits. they don’t have products and hence cannot really be objectively valued. It’s useful to remember the famous aphorism about PT Barnum, “there’s a sucker born every minute.”

    • NMR says:

      Agreed. I’m not a biotech investor for the simple reason I’ve looked at the numbers of some of these companies that have gone public and they’re totally bizarre. Some bright people, next to no assets, little or no revenue, no profits, but lots of potential. Weird

  2. VennData says:

    The failings of the Carter Administration. Hillary thinking about running. And the permanent end of tax cuts.

  3. Concerned Neighbour says:

    I would also note that our illustrious financial media has yet to grasp that “triple digit losses” no longer mean as much at DOW 16K than they did at DOW 9K. The DOW lost 180 points today? Wow, a whole percentage point? Shall I jump from that window now or later?

    Similarly, it’s worth noting that despite the large absolute drops our media loves to sensationalize, the S&P 500 is down a whole ~3% from all-time highs after rising ~180%. Panic time indeed.

    I agree that “markets” do not need a reason to fall a measly 3% from all-time highs. If they fall 20% then we can more reasonably apply a narrative (such as the operators haven’t provided the latest short-term crack fix, the Heartbleed bug has reduced confidence in e-commerce and our commercial infrastructure more generally, etc.)

  4. sellstop says:

    There is a reason that the optimism of the media story is met with selling.
    It is obvious that big concerns are selling. And they need volume to sell to.
    This causes the general market to become weak and then the selling feeds on itself.
    The reason is not usually obvious for months.
    I think it is Putin.
    But I don’t KNOW.

  5. ironman says:

    Posted on March 31, 2014: Extending the Alternate Futures

    Posted on April 7, 2014: The Evolving Future of the S&P 500

    Are you sure nobody has any idea of what is happening with the market? From our perspective, both when and by how much the market would change has been pretty clear, and has been for weeks (follow links above). The only question was which future quarter would investors be focused upon when it happened. The answer turns out to be 2014-Q3, just has it has been since 19 February 2014 when Janet Yellen first set their focus there, so even that was relatively predictable.

    (P.S. We’re well aware of the market’s complexity – it’s taken a lot of effort on our part to develop a decent model that describes how stock prices behave that reflects that complexity and yet is as simple as what we’ve presented. As with any model, it’s wrong, but useful.)

  6. CD4P says:

    Ouch. Time for a pick-me-up after reading that. Chocolate for breakfast, here I come!

  7. eideard says:

    Hear, hear. :)

  8. Lyle says:

    Or recall the quote from John Pierpont Morgan when asked what the stock market would do, he said it would fluctuate. So the idea that much of the day to day movement of the market is just noise is reinforced by this quote. I agree that financial journalists are given time to fill or space to fill (depending on the media), and that providing “reasons” that the stock market moved one way or the other is a good way to fill the space. Of course occasionally there is news that moves the market, but its better to look after a week then sooner as the noise will have damped down.

  9. denim says:

    the media likes corrections… sell at x% drop, then buy back after bottom. works with the indexed etfs/

  10. Personally, I think there is always a story, and in fact it’s always the same story: The market is down today because the marginal buyer is not willing to pay higher prices, and the marginal seller is willing to accept lower prices. But that story is obvious, and it doesn’t sell advertising. The next layer of the story is figuring out who the buyers and sellers are today, compared to the previous mix, and whether today’s participants genuinely believe something has changed (and if so, what). Are highly leveraged players being forced to liquidate to meet margin calls? Are major fund managers rebalancing or changing their minds about overall allocations? Did the market simply exhaust the supply of greater fools with credit to spend on stocks?

    I don’t agree that “old stories”, which the market knew about yesterday or last month, cannot matter today. I think the tipping points in a complex system are much harder to spot. To take one of the standard physical analogies, you can keep adding sand to a pile (or water to a Washington hillside) for quite a while, with no obvious effect other than the pile gets bigger and a few grains slide down. But then, seemingly at random, you’ll get a major avalanche (mudslide). However, that doesn’t make the avalanche random, it just means that there were hidden stresses and hidden weaknesses which built up to the point where the system could no longer hold itself up.

    But I agree with Barry that the level of complexity in the market’s stories is so high that the media aren’t equipped to dig it out, and the typical investor is wasting their time trying to comprehend it as well. It’s sufficiently hard to simply look at the observable facts and make objective decisions!

  11. 4whatitsworth says:

    It is likely that there is no story this time but we should all keep in mind that there is a lot of inside baseball going on (all of our congress folks are rich for some reason!). I remember watching the market fall and it seemed like there was no story then the S&P downgraded US bonds. I also remember watching the market rise and thinking what the heck then suddenly QE3 came to be. Sometimes there is a story we don’t know it yet.

  12. Ben Dover says:

    In the short run it is chaotic Brownian motion, in the longer run you can use some simple tools to identify direction. The problem is you can’t print and sell a paper with the same front page headline and one story for 3-4 years and expect your ad revenues be stable and to remain in business. So instead you have to fill pages with analysts forecasts, macro news, micro news, weather, ad infinitum.

    I mean can you imagine picking up the paper everyday for years and reading: “High cyclically adjusted P/Es, low expected future growth given peak profit margins, and low dividend yields signal low future expected returns for the next 7 – 10 years.” I mean, I guess GMO does that quarterly, but you can’t do it with a daily paper.

  13. Clif Brown says:

    If I recall correctly, Robert Schiller in the first edition of “Irrational Exuberance” highlighted the statistical studies that have proven beyond doubt that there is no connection between events in the news and the market.

  14. Thanks for such a great blog post and thanks for showing the right way of seeing at things ion the financial market. When I was new to the market I used to be bookish and tried to find reason in everything. At that time I used to invest in stocks that were suggested by the daily newspapers. However, I later learned that the stocks or market making news in daily newspapers mean that the bullish run is nearing its end. This is when I learned not to go with what everyone is talking about. This is when I learned Fundamental analysis and later Technical Analysis. First I relied only on fundamental analysis to investment on stocks. However, as time went I started doing my own technical analysis and started investing on the basis of that. I learned next that no matter how the index moves, you can make money either way. When will investing in futures and Options (Call or Put) help? This is when I decided to have a broad analysis of the market movement, keep invested in fundamentally strong stocks for long period to smooth out the seasonal fluctuations, and also make money from either-way movement of stock or indices through options and future trading. It definitely helped me a lot I’ll say.

  15. 3lynx says:

    [...] Barry Ritholtz: Stop Looking for “the Story” Why Markets Are Falling  [...]

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