Is Mr. Market in Denial?

At the close of trading yesterday, the S&P 500 was up more than 19 percent from its Sept. 21 low. The Dow was up more than 18 percent, and the Nasdaq, 34 percent. This despite the fact that up until very recently, the news cycle was dominated by glum reportsabout low consumer confidence and speculation that the United States was sinking into a quagmire in Afghanistan. (On the latter point, see my Slate colleague William Saletan’s excellent “ Frame Game.”) Some of this run-up has happened in the last few days in reaction to more positive economic and war-related news. But the indexes were all on the rise even before that.

So why has Mr. Market been so jolly? (The “Mr. Market” personification device was the invention of Benjamin Graham.) In late September, a few days after the indexes all hit their recent lows, an installmentof this column mused that, fear aside, it seemed more tempting to buy stocks than it had in recent years. But I was thinking more about how the market would do over the long term, and I certainly wouldn’t have predicted double-digit pops in all the indexes within less than two months. So the follow-up to asking about what it is that explains Mr. Market’s good mood is: Can this rally possibly be real? Or is Mr. Market in denial?

One school of thought has long held that the stock market is not quite the reactive thing we often imagine it to be, but rather that it anticipates events. The crash of 1929, for instance, did not cause the Great Depression, but rather predicted it. One recent articulation of these ideas was the book The Message of the Markets, by CNBC anchor Ron Insana, published last year. One of the anecdotes in that book is Insana’s recap of the market’s reaction to the Jan. 17, 1991, launch of Operation Desert Storm. The Dow rose 105 points, and “the greatest bull market to ever take place on Wall Street got its start on the day the Gulf War began.” Insana’s point, and the theme of the book, is that while many experts at the time were predicting all manner of doom and gloom, the collective wisdom of the markets simply “knew better” and knew it sooner.

I’ve never been completely convinced by the all-knowing-markets theory, which is invariably supported with examples that (to me) smack of hindsight. (A famous rejoinder to the market’s supposed all-knowingness is the comment, attributed to Paul Samuelson, that the stock market had predicted nine of the last five recessions.)

I tend to think that the market is extremely good at interpreting current information more quickly and clearly than, say, the cast of TheMcLaughlin Group. On the other hand, I think it’s foolhardy to think that Mr. Market actually sees the future, which is what some true believers essentially argue. Mr. Market is subject to wishful thinking, has an extremely short attention span, and can certainly be taken by surprise. Although the market was more or less flat today, its momentum this week has been so strong that it’s hard to believe its actions make sense. As I’ve notedbefore, I thought some of the more extreme predictions of economic calamity immediately after Sept. 11 were overdone. But are prospects for corporate profits really 20 percent better now than they were seven weeks ago? Maybe Mr. Market really does know things that we don’t. Or maybe he only thinks he does.