I have a big problem with a small word. But before I get to that, I’ll start with a little bit of history.
In his book The Success Equation, Michael Mauboussin tells this story: Back in the 1970s, a Spanish man won the country’s biggest national lottery, called El Gordo—the Big One. Awarded annually at Christmastime, it is the rough equivalent of our Powerball. In this particular year, when the winner was interviewed, he explained how he selected the winning number. He had been looking for a ticket, he said, with the digits 4 and 8 because of dreams he had been having. Specifically, he said that he had “dreamed of the number 7 for seven straight nights. And 7 times 7 is 48.”
While this is funny, the reality is that a lot of financial news—especially at times like this—follows similar logic. For example:
“The Dow Rises as the Market Waits for an Interest Rate Cut”
“S&P Drops as Tech Wreck Weighs”
“Stock Market Rises As Fed Calms Inflation Worries”
On the surface, there may not appear to be anything wrong with these headlines. But there’s the little word I have a problem with—the word as. I think these statements are unhelpful because they imply a straight-line, cause-and-effect link where one may not really exist. The market rose because of this, or fell because of that.
Articles like this appear every day, but the reality is that “the market” doesn’t have a mind of its own. It is merely a collection of individuals. And individuals don’t all think and act uniformly. Every day, innumerable variables combine to impact investment markets. To be sure, there are overriding themes that do drive a good part of stocks’ ups and downs on any given day. But headlines like this suggest that these relationships are simple and predictable when often they are not.
The author Nassim Nicholas Taleb compares the stock market to a billiards table: When you hit the first ball, you can be pretty sure where it’s going to go. And a skilled player might be able to control what happens when that first ball hits the next one. But beyond that, it’s anyone’s guess. Things are just too random.
The stock market is the same way. There are some basic rules of thumb, but they are hardly ironclad or predictable. For example, when a company reports quarterly earnings that exceed expectations, that usually drives the company’s stock higher. But there are lots of exceptions. Sometimes Wall Street analysts deem the results “low quality” even when they are above expectations, and then the stock might go lower, not higher.
Another rule of thumb: When the Federal Reserve cuts interest rates, that tends to drive most stocks higher. But consider what happened a month ago. On March 15, the Fed held an emergency Sunday meeting and announced a rate cut. The market’s reaction? Immediate and negative. Instead of rising, the Dow dropped 13% when the market opened the next day.
These sorts of things happen every day, so it’s clear that investment markets don’t follow simplistic rules. And yet, we continue to see headlines like these, which imply that they do.
Why is this the case? Mauboussin, in The Success Equation, quotes psychologist Steven Pinker. For evolutionary reasons, he says, our minds have learned that to survive we must always be looking to make sense of the world around us. In fact, for survival, it’s critical to understand cause and effect in our environment. As a result, Mauboussin writes, “we string together events into a satisfying narrative, including a clear sense of cause and effect.”
Explanations aren’t just satisfying; they are comforting. The world feels a lot safer when we perceive there to be logic and order, when things appear to happen for a reason. It’s much more unsettling to believe that our lives are governed simply by luck and randomness. That’s why our minds are always looking to make sense of things.
But sometimes, Pinker says, this part of our brain goes into overdrive, telling stories and drawing conclusions even when they’re completely made up. At times like this, he says, the mind becomes a “baloney generator.”
At this point, you might think I’ve gone too deep into psychology. After all, what difference does it make if we tell ourselves some “baloney” stories to make ourselves feel better? What harm could that cause to our finances?
This is a problem, I believe, because we rely on past experience to help guide our future actions. When the news media, or others we see as experts, tell us stories that connect cause and effect in ways that are just made up, we draw conclusions that shouldn’t be drawn and learn “information” that really shouldn’t be learned.
So where does this leave us? As is usually the case, Warren Buffett offers useful guidance. “Games are won by players who focus on the playing field,” he says, “not by those whose eyes are glued to the scoreboard.”
As we navigate this uncertain time, it’s natural to feel a lack of control and to want to follow every piece of news and every tick of the stock market. But I think it may be helpful to take a step back. I don’t know whether it will be this year or next year, but I think it’s safe to say that eventually we will develop a treatment or a vaccine, or both, and then our economy will once again move forward.
As you make investment decisions, I would encourage you to keep that in mind. Keep your focus on the medium and long term and plan accordingly. Don’t worry as much about the day-to-day movements of stock prices—and how commentators explain them.
Will there be bumps in the road? Of course. Is the timeline uncertain? No doubt. But eventually the world will get through this.