A Look into the Market’s Lack of Response to Recent Events

With the President of the United States being hospitalized with a profound, new virus that has caused a global pandemic unlike the world has seen in a century, many investors would logically believe that the stock market would plunge.  The market experienced a brief sell-off in the morning, but despite recent high levels of volatility, the S&P 500 still closed 10 points higher on Friday October, 2.  There were certainly mixed signals being sent regarding the President, with the White House originally describing the action as a “precautionary measure”, then “mild symptoms”, and some reports even detailing a drop in the President’s blood-oxygen levels.  Regardless of mixed reports, one would believe that a 74-year-old, high risk person would have an uncertain future.  

To better understand this lack of responsiveness, we can dive into the world of behavioral finance.  Behavioral finance is described as, “…a sub-field of behavioral economics, proposes that psychological influences and biases affect the financial behaviors of investors and financial practitioners”.  An investor’s psychological state clearly plays a profound impact on markets due to the supply and demand nature of stock exchange.  During major world events, such as the leader of the United States contracting a deadly virus that has killed millions, behavioral finance and investor psychology becomes even more relevant.  This leads to questioning the validity of the efficient market hypothesis.  The efficient market hypothesis provides, “…share prices reflect all information and consistent alpha generation is impossible.  According to the EMH, stocks always trade at their fair value on exchanges, making it impossible for investors to purchase undervalued stocks or sell stocks for inflated prices.”   Part of the definition regarding share prices reflecting all relevant information seems harder and harder to believe in recent history.  It appears that the efficient market hypothesis is rendered invalid on numerous occasions.  

President Trump’s health is not the only event for which the market responded irrationally.  Beginning with the downturn of the market in late March, a “V” shaped recovery followed suit, disregarding much of the news that predicted a wholly different recovery.  An article published by the Atlantic in June writes:

“On Wednesday, U.S. deaths from COVID-19 officially surpassed 100,000, and stocks rose. On Friday, the Commerce Department reported that GDP plummeted nearly 5 percent in the first three months of the year, and stocks rose. Over the weekend, Americans took to the streets of large cities and small towns to protest the killing of George Floyd and call for an end to years of police brutality and systemic racism against black Americans, as their mostly peaceful movements were often attacked by police and beset by chaos tourists smashing the windows of local stores. And stocks rose.” 

This excerpt proves that regardless of grim economic and (socio) political outlook, the market appears to be pulled upwards by some sort of magnetic force.  The notion of the market as a leading economic indicator comes under the most scrutiny in these scenarios.  On multiple occasions this year, pessimistic news have emerged while the S&P and NASDAQ continued their upward hike.  For example, depressing job reports, GDP reports, and GDP Projections made by the Federal Reserve and highly reputable banks have all yielded a positive uptick in the market at some point in the last six months.  

Investors’ psychological sentiment regarding the market and setting the current price level may lead to the notion that the S&P 500, DJIA, NASDAQ and other market indices are poor economic indicators.  The stock market is long considered the number one leading economic indicator, meaning it is one of the first indicators to reflect true economic status.  After a deeper look into behavioral finance and the efficient market hypothesis, it is evident that investor sentiment drives markets.  When extreme world events take place and the market does not react proportionately, it appears that the relevancy of the stock market as a leading economic indicator should be questioned.  Given current levels of high volatility, the market would even be justified in an overreaction to these world events, ie. a large sell-off.  Perhaps during times similar to the present, investors should place more relevancy on other indicators.  The large quantity of fiscal stimulus allows the market to inflate, and become a poorer economic indicator.  The causations for these strange market responses leave many investors in the unknown, although there are some theories.  For events such as job reports and GDP data, some attribute an increase in the market to the fact that although the data reports negative, a greater negative projection was anticipated.  Fiscal stimulus plays a role in inflating prices as well.  With a record number of retail brokerage accounts opened this year, many retailers are putting their checks into the market.  Although there are numerous theories explaining the market’s strange responses, only time will tell if it continually proves an effective leading indicator.  

Works Cited:

Shiller, Robert, J. 2003. "From Efficient Markets Theory to Behavioral Finance ." Journal of Economic Perspectives, 17 (1): 83-104.

Edited by Jaret Prothro