Whatever happened to the stock market? That harbinger of economic vitality, of unemployment, inflation, consumer confidence, interest rates, gross domestic product, productivity, profit, or dividends? Its daily movements have been our proverbial tea leaves for generations, but now it seems to be disconnected from any sort of reality, with wild mood swings that we try to explain as volatility, as though there were at-all-normal data.
Since the post-Depression era of relatively regulated safety, the stock market had been the place where companies went to raise serious capital, and where investors created diversity, or an income stream of blue-chip dividends, or a windfall from riding a growth or value trend.
And over the years, it has been reliable enough to be imbued with predictive powers, pegged as a leading indicator, reputed to run ahead of the economy by about six months or so. Investors invest based on expectations of the future, the logic goes, so an investment today reflects sober analyses of future conditions.
Increasingly, however, the market seems to have little grounding in our economic lives, and little if any reflection of our expectations. Perhaps the pandemic has shifted the predictive relationships we’ve had faith in for a long time. It has certainly created more uncertainty—about how economic life will endure, what consumption and employment will be like, where income will come from—in short, what this sustained and widespread individual distancing will do to a transaction-based economy.
And that makes it that much harder to form expectations of corporate performance. It is not at all clear or even predictable which products, supply chains, distribution flows, and financing models will prove successful, given that we can’t know how people will work, earn, and consume.
But it turns out that the stock market’s performance of late, although it may seem to have less to do with any economic reality, has a lot to do with human reality, that is, with human behavior. It seems that investment has given way to speculation, which is predictable in unpredictable times such as these.
It is easy to understand how a crash can snowball, how once a downturn looks serious, for example, investors try to get out while they can. Or how, once the upturn looks real, no one wants to be left behind. And afterwards, there’s always enough investors taking profits at the high or buying at the low to stabilize the markets with an immediate if not lasting bounce.
The swings of late are more than can be explained by a bounce, but there seem to be a couple of factors at work. For one, volatility itself is traded: using the VIX, an index of stock market volatility designed to be a metric but now traded as a commodity, volatility can be used to hedge or diversify a conventional portfolio. And the more volatility we expect, the more its value as a contrarian asset class. Trading volume in the VIX is spiking, adding its own volatility to the market’s.
And day trading is back. The number of individual accounts established at discount brokers and the amounts invested in them has soared since March, many opened by investors under 40. After coming of age during the dot.com crash and surviving the Great Recession, they are somewhat accustomed to risks, still young enough to want to take them, and still able to make up losses over time. They are more likely to be bored and home alone and there’s an app for that now, and so they try to profit from—while contributing to—the large daily swings in value.
Investment theory has long asserted that the markets are fairly efficient, that is, predictable and rational, but not because their human participants are. Market efficiency stems from the idea that our collective behavior is rational even if our individual behavior is not, because there are just so many investors that the outliers are smoothed away: hence the wisdom of crowds.
Rational behavior would have investors sit tight during periods of extreme unpredictability, like we have now. And, if most of us are sitting this one out, then the traders that are out there are the few periodic rebalancers or tax loss harvesters, or just many more gamblers in quarantine.
Whether it’s the commoditization of volatility or whether the market has been abandoned by its rational, critical mass, perhaps this instability keeps the market from being an economic indicator: now just sound and fury, signifying nothing. Or perhaps it is spot on, showing us that unpredictability and seeming irrationality are just what we can expect.