Can the Stock Market Predict the Future?

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Being an all around hater of the traditional news outlets, I don’t like it when the daily moves of the stock market are mentioned as news. The daily exchange rate isn’t, oil isn’t, mortgage rates aren’t either. Sometimes the overall performance over a length of time is mentioned in the same breath like “The Dow was down below 8,000 today that’s 5% down over the last month”. Generally speaking, I’m not a huge fan of this statistic either.

But, what if the stock market could predict the future? No, that’s not possible. Only psychics can predict the future.

Or is it? Let’s look at some examples:

In 2008 the stock market was down roughly 40%, with a constant downward tick the entire year. We didn’t know we were in a recession until December of 2008, so we went the whole year unsure whether or not we were in deep doo-doo. That means our stocks reflected the down economy before our usually metrics had confirmed it.

The 1990′s were good for investors. Once we crossed the border into 2000 things flattened out, with the NASDAQ crashing but not directly hurting the rest of the economy. In March of 2001 we really started to head south. But it wasn’t until after the events of 9-11 that we noticed anything at all. By the time the National Bureau of Economic Research said we were in a recession, we’d already been in one for a year. Take note, like in 2008, the recession started with an isolated industry that we thought was contained. But like an pestilence, it spread everywhere over the course of 12 months.

Everyone’s favorite period of economic history is the Great Depression. This followed the stock market crash of 1929, the one that supposedly had brokers jumping out of windows (however suicide rates were actually down that year so this is unlikely).

In each circumstance, and just about any other recession we’ve had in this country, the stock market has shown a downward tick before we know we’re in a recession. So I ask the question again: Can the stock market predict the future?

It’s a chicken and egg question actually. Instead of thinking of the market as some mystical oracle of economic strength, look at it as the real metric for confidence in our economy. The stock market’s performance isn’t telling us what the future will hold, the stock market is shaping the future. As investors lose faith in the system, the system ceases to function properly. The same applies to a judicial system, if we all lose faith in how we deal out justice, the system will break. Economics is less stable and understood than law though, so we have more noticeable cycles.

The stock market is a self-fulfilling prophecy, no of a predictor of the future. But that doesn’t mean we can’t use it to our advantage. As the market starts to recover, investors will again put their faith back into the system. So while I (along with many other buckheads) will continue to hate on Shepherd Smith’s mentioning of the day’s stock performance, I’ll still be watching the overall trend to see when we once again put our faith back into the system.

Photo Credit: Izik, azrainman

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By The Weakonomist

The Weakonomist is the founder of Weakonomics. Clicking the picture of the puppy will tell you more about him. If you like what you're reading consider subscribing to the blog, following him on Twitter, and checking out the related posts below. Please consider a donation if you really enjoy Weakonomics. Also keep in mind that nothing I say can be construed as financial advice.

categories: business, economics

http://veryevolved.com/2009/02/dangerous-words/ Patrick is Very Evolved

The market is an odd beast. In some ways it is analogous to Heisenberg’s uncertainty principle – interacting with the market by getting scared or confident can change it’s behavior.

But if we try to conduct a retrospective scientific experiment on past data (which is fixed and can’t be influenced) we can test the question in your title. The question we need to ask of the data is this: How many “downward ticks” have we seen over the last 50 years equal in speed to those in 2001 and 2008 that DIDN’T lead to recession.

My guess would be that there have been lots and lots more 4-6 month declines equal in magnitude that didn’t result in a domino collapse.

But i specifically say 4-6 months here because what you say is spot on Phil – it’s self fulfilling, so the longer it goes on the more likely people are to believe it.

And now were out of the realm of maths and physics and into the messy world of the human brain and behavior.

Cheers
Patrick
http://moneytld.com/ Mike

I think there’s generally one exception, which is insider trading. There’s asymmetric information here. It’s practically guaranteed that Joe Schmos like you and me know less about these stocks than better placed people who may be trading both illegally and legally. It’s like that terrorist futures market that the DoD tried to set up. Markets can be an accurate predictor. Perhaps not the overall market, but there are definitely insiders making trades who can point out likely outcomes.
http://www.personalfinanceplaybook.com Todd

I agree that the market is self-fulfilling. When the analyst start reporting that things are going down in a bad way, institutions start unloading shares. Investors see the market tanking and hear about it from their advisors, so they start selling their shares. The market goes down as money is being pulled out without new money to replace those positions. A reversal of fortune takes time because the big institutional investors need money to buy even the most obviously mispriced securities. They don’t get that money flowing back in until investor confidence is restored. Hopefully that happens asap – who knows?

I’m actually pretty numb to market moves. I’ve been investing long enough not to panic sell. That hasn’t saved me from taking a couple of bad losses in this market (see – Bank of America). Good post.
http://www.doggiebloggie.com Emily

Totally agree with Patrick on the whole “odd beast” take. Whats always concerned me is the part of volatility that hinges solely on the insanely influential opinions the “market movers” have… like Meredith Whitney who can raise a pinky and there goes the stampede. Not like market movers haven’t EARNED themselves the title, as they likely have made correct assumptions for long enough to gain this kind of attention/respect, but eventually like all humans one day they are going to have to be wrong, and it could very well be that their “oops” ruined your life in one fell swoop. Of course we are all hypocrites in our own right; and if I was given the choice of Warren Buffet or Britney Spears to pick me out a handful of sweet stocks I’d have to pick the first, but at least we all know in the back of our heads that crazy Britney has just as good of that random chance as Warren in scoring us a hit. and that is scary.

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Can the Stock Market Predict the Future?

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