The Message of the Markets

Thursday, January 25, 2007 | 07:22 AM

I have said in the past to "Beware the Economist who is seeking guidance from the stock market as to the state of the economy. These creatures make lousy economists and worse money managers."

Jim Welch takes this a step further, explaining the "message of the markets:"

"Over the many years I have been following and learning about the economy and financial markets, I have heard comments used repeatedly by presumably knowledgeable experts as they discuss various markets. People will say the markets are a discounting mechanism, and that markets anticipate events, as when stocks bottom before an economic recovery. Some people will go so far as saying that a particular market is telling us a specific outcome is coming based on how that market is trading.

After listening to these comments when I was younger, I too believed that “markets” were indeed imbued with a special instinct about the future. If I could just learn to listen to them, I would learn something I wouldn’t get out of a financial newspaper or research report. One of the CNBC anchors has even published a book entitled “The Message of the Markets”. Of course, the message is always clearer with the benefit of hindsight. I know I would have done better in school, if I could have just taken all those tests, after having already taken them once!

In 1982, the stock market had spent 16 years going nowhere, which prompted Business Week to publish a cover story entitled “The Death of Equities.” Somehow they didn’t get the market’s message that a 1,200% increase in 18 years was about to commence. When the stock market crashed 22% in one day in 1987, almost double the decline on Black Tuesday in 1929, was the market telegraphing a coming depression? And when the Nasdaq zoomed past 5000 in 2000, was it proclaiming that we had arrived in a “New Paradigm” Paradise? A list of examples showing that markets are always wrong at important turning points could be a very long list.

Needless to say, I don’t subscribe to the notion that markets ‘know’ much about the future. Markets are a reflection of recent trends and what a majority of investors have come to believe at that moment, in response to the recent trend. And, when a majority of investors are fairly certain of an outcome, the probabilities rise that something other than what is expected is likely to occur."  (emphasis added)

-E. James Welsh

We have said this previously, but it bears repeating: The crowd is right much of the time. However, the crowd can easily become an unthinking mob. They tend to be wrong at the worst possible moment, most especially at turning points.

Good stuff. Thanks, Jim.

Thursday, January 25, 2007 | 07:22 AM | Permalink | Comments (18) | TrackBack (1) add to | digg digg this! | technorati add to technorati | email email this post



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» The Infallibility of Markets from The Big Picture
Yesterday morning's comments, The Message of the Markets, generated some interesting pushback. Felix at RGE, Abnormal Returns, and even here in comments. I got calls from some people telling me why I was wrong, as well as people who said they would lov... [Read More]

Tracked on Jan 26, 2007 7:50:21 AM


Interesting article, but I think James Welsh's view of the markets are a little too jaded. His greatest mistake, I believe, is not to discriminate between markets. For example, while all financial assets are priced by effectively discounting expected future cash flows, the stock market has a less direct relationship to expectations for the economy than, say, the fixed income market (government bonds). The information content in the yield curve surely tells us more about the economic future than any measure of the Dow or S&P. And then there are markets in even more direct measures of the economy, such as the relatively new economic derivatives that are traded through the CME, albeit on a very short tenor.

Lastly, isn't the point about crowds being wrong at turning points just a truism?

PS - I believe the crowd (mkt) is wrong nearly all the time. Unfortunately, I have little idea about what is right, and whether and when the market will get there.

Posted by: Caravaggio | Jan 25, 2007 7:55:49 AM

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