Robert Shiller says the stock market rally from the March lows is nothing more than investor FOMO. He says that it may also be because of the fear of missing out.
Shiller, a 2013 Nobel laureate in economics and Professor of Economics at Yale University, published an article yesterday. In it, he attempted to explain the disconnect between the stock market rally and the overall economy. The economy continues to struggle with coronavirus pandemic.
Shiller starts by asking a simple question: “With cratering demand dragging down investment and employment, what could possibly be keeping share prices afloat?”
He says that the economic fundamentals and market performance can diverge. When this happens, “the deeper the mystery becomes, until one considers possible explanations based on crowd psychology, the virality of ideas, and the dynamics of narrative epidemics.”
Effects of Investor Reactions
The reason the market can rally despite the poor economic conditions is how investors react to the news. Alternatively, “investors’ assessments of other investors’ evolving reaction to the news, rather than the news itself,” as Shiller says. This means we are investing based on our best guess how other investors will react to the news.
Shiller also points out that the pandemic wasn’t a “familiar event” to investors. This means they didn’t have experience with a pandemic. Therefore, they didn’t have the capacity to use past occurrences to base their investing decisions on. He also says that because investors didn’t see the market react when the pandemic took hold in China, there was a sense that the outbreak itself was a non-event.
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“Their lack of past experience since the 1918-20 influenza pandemic meant that there was no statistical analysis of such events’ market impact. The beginnings of lockdowns in late January in China received scant attention in the world press. The disease caused by the new coronavirus didn’t even have a name until Feb. 11, when the WHO christened it COVID-19.” said Shiller.
The markets went through three phases, says Shiller. The first phase began when the World Health Organization declared the new coronavirus “a public health emergency of international concern” on January 30. It lasted through the market hitting an all-time high on February 19.
The second phase lasted from February 19 to March 23. During this time period, the S&P 500 plummeted 34%. This drop similar was to the 1929 stock market crash.
Shiller says the third phase started on March 23 when the stock market rally started it’s 40% rally. “On March 23, after interest rates had already been cut to virtually zero, the Federal Reserve announced an aggressive program to establish innovative credit facilities. Four days later, Trump signed the $2 trillion Coronavirus Aid, Relief, and Economic Security (CARES) Act, promising aggressive fiscal stimulus,” says Shiller.
Here, Shiller says, is where FOMO kicked in and the market rally took hold.
“Most people have no idea what’s in the Fed plan or the CARES Act, but investors did know of one recent example when such measures apparently worked.
“Stories of smaller but still significant stock-market collapses and strong recoveries, a couple of them from 2018, were widely recalled. Talk of regrets about not buying at the bottom then, or in 2009, may have left the impression that the market had fallen enough in 2020. At that point, FOMO (fear of missing out) took hold, reinforcing investors’ belief that it was safe to go back in.” says Shiller.
So next time you see bad economic news, or another company filing for bankruptcy and you wonder why the stock market keeps heading higher, remember what Shiller says.
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“Price movements are not necessarily a prompt, logical response to (the news). In fact, they rarely are.”