And Fairy Tales
FiLife Take: The huge downturn in the market last Monday wasn't the end of the world. The upturn at the end of the week didn't magically cure anything either. Jason Zweig tells readers to sit on their hands and just try to make sense of the market madness.
In the week that just ended -- and thank goodness it did end -- the Dow Jones Industrial Average went through four out of the 25 wildest intraday point swings on record back to 1977. And no wonder: On Monday, with investors fearing that Wall Street itself might be wiped out, the Dow lost more than 500 points. By Friday, with the government stepping in for the largest bailout in financial history, the selling panic had flipped into a buying frenzy, and investors everywhere breathed a sigh of relief.
It seems like something right out of a Harry Potter novel: Treasury Secretary Hank Paulson and Fed Chairman Ben Bernanke don wizard robes, wave their wands, mutter "Wingardium leviosa," and the moribund financial markets rise up from their crypt as hale and hearty as if subprime mortgages and credit-default swaps had never existed.
What makes otherwise intelligent investors believe such nonsense? Just as the financial world wasn't really coming to an end at the beginning of this week, it hasn't been miraculously cured of all its ills by government intervention at the end of the week.
Buying into a euphoric upswing is just as foolish a mistake as selling into a miserable downturn. What you should do now is take your hands, place them carefully palm-up on the nearest chair, and sit on them.
Then take a few moments to make some sense of this latest round of market madness.
Look back at the headlines in newspapers over the past few days. The market wasn't just going up or down; it was soaring and plunging like a wild beast. A 410-point move is so big that it seems to create its own momentum, the same way a charging bull or bear might seem to have a hard time changing direction on a full head of steam.
Thus a huge down day like last Monday fills you with dread for the next day, while giant up days like Thursday and Friday have you looking forward to next week. Yet a 410-point rise tells us precisely as much about what will happen next as a 4.1-point rise -- nothing.
Unfortunately, such big swings do give you an uncanny sense that the market is in motion, and physical motion seems inherently predictable. Babies as young as nine months automatically expect objects in motion to continue along the same trajectory. As adults, that serves us well in most of daily life.
Trends in the markets aren't so easily predictable. Yet the vivid words and images that we in the media use to describe the markets make the future seem all the more certain. Psychologist Michael Morris of Columbia Business School has found that seemingly slight changes in how a market rise or fall is described can make a big difference in investors' expectations. When investors looking at a rising price chart are told that an investment "climbed" today, they are about 10% more likely to predict that it will go up tomorrow than people who are told that it "increased" by an identical amount. Conversely, someone who sees that a stock "dove" is almost 20% more inclined to predict it will drop tomorrow than somebody who is informed that its price "decreased" by the same amount. That's because words like "climbed" and "dove" imply that the market is alive, that it knows what it is doing and that it will keep doing it.
Prof. Morris also discovered a striking asymmetry in how commentators describe the market's moves. On up days, pundits and headline writers are much more likely to use words like "climbed," "jumped" or "rallied" -- language full of intention, as if the market were rising by an act of its own willpower. On down days, however, the commentariat tends to use words like "fell," "slipped" or "slid" -- language that seems passive, as if the market is not in control of its own destiny. This difference makes you more inclined to expect the market to go in the same direction after a "jump" than after a "fall."
So, despite the abracadabra routine being staged in Washington, the stock market hasn't suddenly become predictable, and the future hasn't become miraculously clear. One of the only certainties is a mushrooming Federal debt as the Treasury borrows to fund the bailout of Wall Street's shameful bacchanalia. Meanwhile, Treasury Inflation-Protected Securities, or TIPS, while not cheap, are still worth a look. The underlying value of this security automatically rises with inflation each year. Now is no time to take the risk of having no inflation protection in your portfolio.
Visit WSJ.com now for additional insight on the most important stories of the day.
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