The Stock Market Rose Today. No One Knows Why

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Before any misunderstanding creeps in further, the headline you see here was taken from a Tweet made by Greg B Davis that was shared by my American colleague Morgan Housel in a fantastic article he wrote yesterday.

And, for me and Morgan, my headline here today is perhaps the most honest headline anyone can have in the world of finance.

Yesterday evening, I wrote an article titled Three Shares That Beat The Market Today and talked a little about Janet Yellen’s remarks about the US economy. Yellen, a nominee to replace outgoing US Federal Reserve chairman Ben Bernanke, mentioned that the American economy and labour market were “performing far short of their potential.”

The Fed has set certain unemployment and inflation rate targets the US has to meet – think of it as certain ‘growth signals’ the country has to send out – before it will consider tapering its quantitative easing (QE) programme, which sees the Fed buying up US$85b worth of financial assets per month in an effort to jumpstart the American economy.

One of the effects of the QE programme, according to a multitude of market commentators, would be the rise in asset prices – i.e. stock market prices.

So, given an American economy that is “far short” from its potential, it seems plausible to conclude that Yellen, in her likely-role as new chairperson of the US Fed, would not be cutting back on the asset-purchases until the country displays better growth.

Given such a backdrop, and the fact that the Straits Times Index (SGX: ^STI) was up 0.8% to 3,191 points yesterday, I could have easily pointed to Yellen and said, “Thank her for the market rise.” In fact, that was what a few headlines suggested (see here, here, and here).

But I didn’t. In fact, I did not even acknowledge why the market rose. Because the truth is, no one knows.

In the long-run, it’s true that the Fed’s QE programme might have had a big role to play in the global stock market’s climb from the pits that were dug during the Great Financial Crisis, which started roughly six years ago in 2007. After all US$85b of freshly-minted money every month has to go somewhere right?

But crucially, in the short run, (sometimes in just 24 hours as in the case of my Three Shares article), how could anyone tell if it was Janet Yellen’s words that caused the market to climb?

Sure, it might seem possible that markets around the world rose slightly because of the implications behind Yellen’s words. But, how can anyone prove that?

To me, it seems like an exercise in seeing causation when all there is, is correlation. And, that is a psychological phenomenon that afflicts the majority of us, but it’s a story for another day.

Coming back to the stock market, I do have to acknowledge that sometimes, it is clear why certain shares move a certain way, even in the short-term.

For example, in the same Three Shares article I referenced earlier, I also wrote about Asia Power Corporation’s (SGX: A03) 39.6% jump in a single day to S$0.148.

That’s a large movement. But it had a specific reason: the company received a buy-out offer from Asiasons WFG Capital Pte Ltd for S$0.16 per share in cash. So if anything, the large jump to a price that was still a fair bit below the buy-out offer might even have reflected some doubts about the acquisition taking place. But, it was clear why its shares moved big.

In other recent instances, we saw medical device maker Biosensors International (SGX: B20) and electronics and furniture retailer Courts Asia (SGX: RE2) drop 6% and 10.3% respectively on Wednesday. What happened? Well, both saw their quarterly profits get slashed by more than 50% compared to a year ago.

If we extrapolate that kind of poor performance into the future for Biosensors and Courts Asia, their futures look dim indeed. Of course, we shouldn’t extrapolate one quarter of performance in that way. But at the very least, the companies’ drop in their share prices reflected the general (and sane) idea that businesses with shrinking profits will see their true economic value shrivel in tandem over time.

But just as there are good, logical reasons for certain shares’ movements over the short-run, there are just as many instances where I literally scratch my head and go, ‘What just happened here…?’ when I open up Yahoo Finance’s daily Price Gainers and Price Losers list.

Turns out, there are many, many instances when shares move big in a day or two for no apparent reason at all. Perhaps, that’s why Benjamin Graham, author of the seminal investing-text The Intelligent Investor, wrote in his book that “In the short run, the market is a voting machine but in the long run, it is a weighing machine.”

In the short run, whimsical and fleeting human emotions dominate the markets and it is really anyone’s guess as to why shares rose or fell. Perhaps it’s just the weather or a poorly-seared plate of char kway teow certain traders had for lunch that caused some poor moods? I really wouldn’t know.

In the long run however, we can clearly see how things shape up. Oversea-Chinese Banking Corporation (SGX: O39) has had total returns (capital gains plus dividends) of close to 450% since the start of 2003 to today. And from 2003 to the last twelve months, OCBC’s total assets have grown from S$85b to S$321b while profits have increased by 185% from S$954m to S$2.72b. That’s the weighing machine at work.

The next time you see your shares jump or plummet, before rushing for the headlines, look for important business announcements made by the company, such as acquisitions or mergers; new product/service announcements; or earnings releases.

If there are such announcements, take your time to think through the implications that the announcement has on the business. In particular, think about how the real economic value of the business might change in the future with the announcement.

In the meantime, from the way I see it, “The Stock Market Rose Today. No One Knows Why” should be the most common headline we ought to be seeing.

But the problem is… that headline can’t sell, can it?

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chong Ser Jing doesn’t own shares in any companies mentioned.