“The market fell by 500 points today & the reason was (pause for effect) (some drumroll) we have absolutely no idea.”
I wish it would be that easy. Whenever I scan the newspapers & there’s a commentary about the market performance of the day before, it always has a cause associated for the rise & fall in the market. Even if the movement is as insignificant as 0.5%. There has to be a cause.
The most recent reasons that I have been reading are, “The Greek crisis”, “Slow pick up from US”, “QE3, or not (depending on what you want to prove)”, “Corruption”, “Fiscal Deficit” & so on. Are these reasons incorrect? Well, we don’t need to jump to such conclusions, but we need to ask, are these the only reasons because of which the market fluctuates? The reasons also vary as per the seasons, the headlines emphasize whatever is in the news recently.
There are several theories about how & which information is incorporated in the market. There are research papers upon research papers trying to decifer the process of finding the true cause of any market reaction. There are algorithms fed into computers which constantly search for exactly the same information predicting the next market reaction (or sometimes even causing the reaction). So after numerous citations in these papers & gigabytes of commentary by writers & jouranalists, what do we know about “the real reasons” to what do markets respond to? Zilch. We know nothing. That is, we know nothing conclusively. We can ask immediately about the latest global headlines & attribute those as a cause for the market reaction. But that is classic Recency Bias.
Well, we can go quitely thinking that we don’t know, so is there any point in investing at all? In fact we can incorporate this very lack of knowledge into our investment process to protect ourselves of the emotional turmoil of market volatility. We can logically understand that the market pretty much resembles a complex adaptive system. Such a system doesn’t have just a few variables that affect it, but a whole bunch of variables acting at the same time which we may or may not be able to figure out every time. Given the limited amount of resources that we have, it’s best to leave figuring out all the variables to the commentrators.
What we can do instead is to accept our lack of knowledge. We can build a process of investing which will make us focus only on those details that will help us find cause & effect relationships at a much smaller scale. We can look at individual businesses & study them piece by piece to figure out the variables affecting that business. This will give us a better chance of figuring out the big picture for that particular business/industry rather than diluting our understanding in figuring out what the market just did.
Next time when we come across “the reason” for why the market fell or went up, pause for effect, smile & go back to reading the annual reports.