OK, so on some days stocks really do go in just one direction (see “Dot-Com Mania Is More Selective Than You Think“). In any case, even though all we’re going to get for the next 24 hours (at least) are a parade of commentators offering up a host of explanations for today’s massive sell-off in the Nasdaq and the Dow, the best rule to follow is just to assume that all those explanations will be wrong, or at the very least inadequate. Sell-offs can get triggered for one reason and continue for different reasons, they can reflect genuine changes in investors’ ideas about the future or simply panic, and so on. Short-term market moves are, almost by definition, impossible to parse successfully.
Having said that–and you knew this was coming, didn’t you?–there are a couple of interesting things to note about what happened today. The first is the resurgence of the idea that rising interest rates actually do matter to stock prices. (I’ll have a piece on this for tomorrow.) The second is that when something like today’s sell-off happens, it makes obvious the extent to which, in the short term, you can no longer separate the event from the media’s coverage of the event.
What I mean by this is that today’s sell-off does not happen in a vacuum. On the contrary, thanks to the spread of the Internet and the rise to prominence of CNNfn and, above all, CNBC, the sell-off occurs with real-time commentary, real-time commentary that is already, almost before the fact, labeling what’s occurring as “a sell-off,” a “prelude to a correction,” or “the first prick of the tech-stock bubble.” And this is commentary that the investors who are making the decisions that will either continue or end the sell-off are hearing as they are trying to make those decisions. In other words, what the media is saying becomes part of the information that is influencing how stock prices are determined.
This matters because the true magic of a market, as I’ve written about before, is the ability of its collective, but decentralized, intelligence to reach conclusions that are smarter–more accurate–than the conclusions any single member of the market could reach, which offers some evidence for this. That’s why markets are better at allocating capital and setting prices than any planning board ever could be. The problem is that most of the experimental evidence on collective decision-making shows that groups make better decisions when each member of the group reaches his or her decision independently of everyone else. In other words, it’s not through an open debate or an attempt to reach a consensus that the best conclusion is reached. It’s only through the aggregation of independent individual conclusions that it is.
But when CNBC is running a show called “Special: Tuesday’s Sell-off,” and its analysts are doing real-time commentary from the market floor talking about how “traders” are feeling, it becomes much harder for investors to reach an independent decision about the only question they should actually be considering: What are these stocks actually worth? This is, again, a signal-to-noise problem (see “Going Bananas Over Stock Splits“). The signal is material information about companies’ future earnings prospects, about interest rates, and about inflation. Noise is just about everything else. But in today’s media-saturated investing environment, the short-term noise can be overpoweringly loud.
In the long run, hard as it may be to believe, this does not matter. (Which is one reason why bubble talk is overblown.) But in the short run, it’s a recipe for increased volatility. So huge price swings are probably with us to stay. Yet another good reason not to adopt a trader’s mentality.