- The markets are often described as efficient – everything that can be known is immediately reflected in share prices.
- Today, Alexander Green explains why this investor wisdom irks “experts” so much.
In my last column, I pointed out that the world economy cannot return to normal until we have a successful treatment and vaccine for the coronavirus.
Yet health experts tell us that these are at least 12 to 18 months away.
But the big bounce in the stock market indicates we will have them much sooner.
Why should anyone trust the consensus of millions of investors rather than the world’s foremost scientists and researchers?
Track record, for starters.
Rational, self-interested men and women consider the economy, interest rates, commodity prices, regulations, technological developments, pending legislation and the future prospects for various industries and incorporate all this information into share prices each day.
These investors aren’t just offering an opinion.
They are taking risks that will result in significant losses if they are wrong.
That’s why markets are often described as efficient. Everything that can be known is immediately reflected in share prices.
You’re skeptical that “greedy” investors could possibly know better than highly trained scientists and policy makers?
Consider the space shuttle Challenger.
At 11:38 a.m. on January 28, 1986, it lifted off its launch pad at Cape Canaveral. Seventy-four seconds later – and 10 miles higher – it blew up.
The launch was televised live, so the news spread quickly.
Within minutes, investors began bailing out of the four major shuttle contractors: Rockwell International (NYSE: ROK), which built the shuttle and its main engines; Lockheed Martin (NYSE: LMT), which managed ground support; Martin Marietta (NYSE: MLM), which manufactured the ship’s external fuel tank; and Morton Thiokol, which built the solid-fuel booster rockets.
All four stocks were hit hard initially.
But by the end of the day, three of them were down just slightly. Only Morton Thiokol closed sharply lower.
There were no public comments that day singling out Morton Thiokol as the guilty party.
And it would be six more months before a presidential commission concluded that the company’s O-ring seals were the culprit.
Yet the stock market immediately identified Morton Thiokol as the company responsible for the disaster.
How could investors know something that even NASA scientists did not?
Author James Surowiecki calls it “the wisdom of crowds.” What “all of us” know is far greater than what any individual or elite group can know.
Evidence of this is all around us.
Remember the old TV show Who Wants to Be a Millionaire with Regis Philbin?
When a contestant was allowed to query an expert of his choosing, that expert gave the right answer 65% of the time.
But when the contestant polled the audience – a random group of people with nothing better to do on a weekday afternoon than sit in a TV studio – they picked the right answer 91% of the time.
(This was before the advent of smartphones, of course.)
We prize and honor the intelligence of experts. Yet, counterintuitive as it may seem, crowds are smarter.
Experts don’t like that, of course.
(That’s why billionaire money manager Ken Fisher refers to the stock market as “The Great Humiliator.”)
Following the Great Recession, I spent years on the lecture circuit trying – and often failing – to persuade investors that rising stock prices weren’t a “dead cat bounce” or a “bear market rally” but a powerful signal that the economy was on the mend.
After a few years, I started calling it “The Most Disrespected Bull Market of All Time.”
Rising share prices were a clear signal that the outlook was improving. But folks looked around or – worse – backward and concluded it wasn’t.
Many of them missed the longest-running economic expansion and bull market of all time.
Don’t miss the next one.
I’m not a virologist or epidemiologist, as some readers have pointed out.
But after 35 years as a portfolio manager and research analyst, I do understand a few things about how to read the stock market.
Lately it has said loud and clear that the economy will snap back quicker than most expect because we will have a coronavirus treatment and vaccine sooner than most expect.
Skeptics are encouraged to keep posting contrary opinions.
I promise to quote the best of them in a few months, when we start getting inoculated.