Skip to main content

You are here

Blog Listing Page

Putting the current market on the couch

By: Tom Goodwin, Sr. Research Director

Nobel economist Robert Shiller recently wrote an op-ed piece in the New York Times on psychology and the market.[1]  He draws on the field of narrative psychology, which suggests that popular narratives are powerful motivators. His observations are especially relevant for today’s market. It has plummeted since the beginning of the year and everyone is struggling to make sense of it.

I have sympathy for journalists who must come up with plausible stories for market fluctuations even when none is obvious. So as the market continues to fluctuate, we seem to get a new story every week. Could it be that these stories are as much drivers of the current market as explanations of it?  

At first it was all about China and the decline of its stock market. Long-standing concerns about over-investment, shadow banking and the accuracy of official statistics suddenly loomed large in some commentaries. The narrative tended to encourage exaggeration of the importance of the Chinese economy for global growth, never mind that US exports to China accounts for 0.6% of GDP, and not much more for other developed economies.   

Then we heard that it was all the Federal Reserve’s fault for raising rates, never mind that the modest rise was clearly signaled so far in advance that only a Rip Van Winkle could have been surprised. Now we hear the market is a harbinger of a coming recession. I am reminded of a quip by another Nobel economist, Paul Samuelson: “The stock market has forecasted 9 of the last 5 recessions.” He said that 50 years ago. It’s just as true today.

But for an economist like myself, the stock market’s obsession with oil prices is the most puzzling. Since December, there’s been a nearly 90% correlation between oil prices and stock prices.  When oil has dropped, stocks have followed. This is historically rare and hard to rationalize because there are only a few corners of the stock market where cheap oil is actually bad news – oil producers, obviously, and banks that have lent money to shale-oil drillers. Cheap oil is a boon for most companies. Take air transportation: jet fuel is the single largest variable cost in that industry and the drop in oil prices has resulted in a sharp increase in their profits. Yet the Air Transport sector of the all-cap US Russell 3000® Index has fallen in lockstep with the price of oil to the tune of -12.9% year-to-date as at 3 February 2016.

There are several stories circulating to explain this. One story is that the fall in oil prices tells us that global demand - especially demand from China – is weak.  But in fact, global oil consumption has been growing at a steady pace, with no sign of a slowdown.[2] What has changed is a huge increase in supply from US oil-shale production and the reopening of supply from Iraq and Iran.

Another story is that cheap oil directly hurts the US economy. The oil patches of North Dakota and Oklahoma have indeed been hit hard. But the US is still a net importer of oil and the drop in oil prices amounts to a windfall for consumers. One study estimates that Americans have an extra 10 billion dollars to spend every month.[3] So reading a lot into oil prices is problematic at best. Boom and bust cycles within the industry are common, and they often have nothing to do with the larger economy.  

Sources: FTSE Russell and the Federal Reserve Bank of St. Louis.  Data as at 3 February 2016. Past performance is no guarantee of future performance.  Please see the end for important legal disclosures.


But once a narrative becomes popular it can take on a life of its own. Many might think that if everyone else is going to sell when oil prices fall then they’d better too, regardless of whether they believe the narrative. The herd instinct takes over and the narrative can become self-fulfilling.  

So given the dearth of truly bad news, will the market bottom out soon? Time will tell, but I’m reminded of a quip from another famous economist, John Maynard Keynes: “The market can stay irrational longer than you can stay solvent.”


------------------------------------------------

[1] Robert Shiller, “How Stories Drive the Market, New York Times, January 22, 2016

[2] IEA (2015), Energy Statistcs of OECD Countries 2015, OECD Publishing, Paris

[3] James Surowieki, “Tanking,” The New Yorker, February 8 & 15, 2016, page 40.

 

© 2016 London Stock Exchange Group companies.

London Stock Exchange Group companies includes FTSE International Limited (“FTSE”), Frank Russell Company (“Russell”), MTS Next Limited (“MTS”), and FTSE TMX Global Debt Capital Markets Inc (“FTSE TMX”). All rights reserved.

“FTSE®”, “Russell®”, “MTS®”, “FTSE TMX®” and “FTSE Russell” and other service marks and trademarks related to the FTSE or Russell indexes are trade marks of the London Stock Exchange Group companies and are used by FTSE, MTS, FTSE TMX and Russell under licence.

All information is provided for information purposes only. Every effort is made to ensure that all information given in this publication is accurate, but no responsibility or liability can be accepted by the London Stock Exchange Group companies nor its licensors for any errors or for any loss from use of this publication.

Neither the London Stock Exchange Group companies nor any of their licensors make any claim, prediction, warranty or representation whatsoever, expressly or impliedly, either as to the results to be obtained from the use of the FTSE Russell indexes or the fitness or suitability of the indexes for any particular purpose to which they might be put.

The London Stock Exchange Group companies do not provide investment advice and nothing in this article should be taken as constituting financial or investment advice. The London Stock Exchange Group companies make no representation regarding the advisability of investing in any asset. A decision to invest in any such asset should not be made in reliance on any information herein. Indexes cannot be invested in directly. Inclusion of an asset in an index is not a recommendation to buy, sell or hold that asset. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional.

No part of this information may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior written permission of the London Stock Exchange Group companies. Distribution of the London Stock Exchange Group companies’ index values and the use of their indexes to create financial products require a licence with FTSE, FTSE TMX, MTS and/or Russell and/or its licensors.

The Industry Classification Benchmark (“ICB”) is owned by FTSE. FTSE does not accept any liability to any person for any loss or damage arising out of any error or omission in the ICB.

Past performance is no guarantee of future results. Charts and graphs are provided for illustrative purposes only. Index returns shown may not represent the results of the actual trading of investable assets. Certain returns shown may reflect back-tested performance. All performance presented prior to the index inception date is back-tested performance. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. However, back- tested data may reflect the application of the index methodology with the benefit of hindsight, and the historic calculations of an index may change from month to month based on revisions to the underlying economic data used in the calculation of the index.

 

 

 

Blog Listing Page