The Seemingly Randomness of the Stock Market

It is utterly amazing how little volatility we’ve witnessed in the stock market over the past six months. The world seems to be a more dangerous and unstable place every month. Think about the big geopolitical events happening right now:

• The ongoing civil war in Syria
• The terrorist infiltration of northern Iraq
• Political unrest and violence in Ukraine preceded by the Russian land-grab of Crimea
• The latest military conflict between Israel and Gaza
• Chinese aggression in the Pacific

All of these events continue to play out as we speak. Now imagine you were on a safari with no access to the internet or any news since the first of the year. Were someone to tell you about these events, what would your gut tell you about the likely direction of the stock market?

Most rational people would assume stocks had gone south because of all these negative events. Yet the reality is, since January, the market has basically continued to rise month by month, hitting an all-time high as recently as July.

This paradoxical relationship confuses most people. It also has a tendency to lead to poor decisions by investors. Most of the poor decision making comes in the form of individuals trying to jump in and out of the market. At this point, “investing” becomes “speculating,” two very different things.

To be successful, investors must remember that the daily, monthly and even annual moves in the stock market represent a lot of “noise” that has nothing to do with fundamentals. Prices will swing up and down for all sorts of reasons that no one will ever fully understand.

Benjamin Graham once said, “In the short-term, the stock market acts like a voting machine, in the long-term it is a weighing machine.” In effect, Graham was saying that short-term moves in individual stocks or the entire market tend to be driven by things such as investor sentiment and “what’s hot.” However, over time, the economics of an asset ultimately determine its value.

So as you watch your favorite newscast, don’t be surprised to see the stock market moving in a direction that seems inconsistent with the day’s headlines. Markets are driven by a mix of emotion and objective financial data. In the short-term, this combination is as unpredictable as when and where the next earthquake will strike.