The way the American media covers the economy, you'd think the only things people care about are oil prices, unemployment figures, and the daily ups and downs of Dow Jones Industrial Average. One day, stocks are flying high (up a fraction of a percentage; statistical noise). Everything is good. Everyone's happy. The next day, stocks are down (more statistical noise), and there must be a single deep-seated reason.
That line of thinking is very wrong.
The Media Loves a Horse Race
You've probably how American political coverage revolves around polls. Did Candidate A commit a gaffe? How did that affect his latest poll numbers? Did Candidate B give a brave speech at a rally? What do pundits expect this to do to her polling?
Even in all of this noise only one poll matters: the votes cast on an election day. Yet that won't keep the audience coming back every day for eighteen months. Even if the race is a foregone conclusion, if there's a new narrative with daily twists and turns, the audience just might eat up that false excitement every day.
Similarly, reporting on the daily ups and downs of the stock market (or, more accurately, the daily fluctuations of an oversimplified single index) gives the impression that you just can't miss out on a single explanation of what happened in the stock market today. If you care about your investments at all, you have to keep tuning in every day—that's what they want you to believe.
If there were more accurate reporting, you might hear:
- "A pension fund sold a lot of IBM stock today to take a profit"
- "The Dow goes up or down by a fraction of a percent every day; it's meaningless noise"
- "Stocks went up today because it's payday and 401(k) funds just bought in"
- "Millions of transactions happened today, and the result produced an equilibrium a lot like yesterday's"
... and other boring explanations, all of which can simultaneously be true. Sometimes you do see a glitch and an interesting story, like when automated trading algorithms feed on each other and cause a massive sell-off, but exchanges tend to step in and even roll back trades when this happens.
Do Political Narratives Drive Stock Prices?
If you listen to daily stock reports long enough, you'll hear that investors are simultaneously and somehow exclusively worried about inflation in Europe, deflation in Europe, changes in the price of oil, economic indicators released by the federal government (trade numbers, deficit projections, unemployment numbers, housing starts, retail sales growth, orders for durable goods, et cetera), speeches given by members of the Federal Reserve, Russian/Iranian/North Korean/ISIS aggression, Ebola, Greek debt default, Greece leaving the Eurozone, Greece staying in the Eurozone, and American elections.
As an investor, have you ever made a trade based on any of those things? What makes you think millions of other investors do, all day, every day, any day?
This kind of investment reporting is an attempt to tie two events together. There may be a correlation (Putin's aggression in the Crimea may affect the intrinsic value of certain companies which do business there, but will that really affect the bottom line of Coca-Cola or Facebook in any measurable way), but it's silly to say that one political action is the cause of buying or selling huge swaths of stocks.
Does Reporting on the Dow, NASDAQ, or S&P 500 Reflect Reality?
Why "huge swaths of stocks"? Because the numbers reported—the Dow, sometimes the NASDAQ, sometimes the S&P 500—are only samples of the market as a whole. There are only 30 stocks on the Dow. They're big, important American businesses to be sure, but do they really reflect the entirety of global or even only American industry as a whole?
Why Do Stock Prices Change Every Day?
On any given day, one stock might see a huge drop in its price as the company announces an impending bankruptcy. Another stock might see its price rise on rumors of a buyout or drug approval from the FDA or much better than expected revenue. That is the reality of the stock market. Big, dramatic swings happen to specific stocks for specific reasons.
As for the normal smaller price changes, buyers and sellers come together every day to see if they can agree on a current price for a stock. The value of that stock depends on many things, including various types of analysis. Some days, consensus is easy to find. Other days, the difficulty of selling shares of a smaller stock means that the last price will linger for a while, and any single trade has a much larger effect on the daily close.
Political and economic actions do affect the global economy. The collapse of banks in 2008 hurt the lives and livelihoods of millions of Americans (and billions of people in the world), and the stock market as a whole reflected that. Similarly, the Fed's Quantitative Easing program made billions of dollars available in the stock market, which contributed to prices rising.
Yet these macro reasons aren't the reasons given for the Dow going up or down every day—do the reporters who cover stocks have the time to explain a global financial story that plays out over months and years?—and they may not be reflected in the year over year long term growth of your portfolio.
If you're a buy and hold investor, looking for great companies to buy at good prices and hold forever, this daily noise is just that: noise. Ignore these daily stock market reports. Good businesses are built to last. Find them. Invest in them. Let them make money and you'll build wealth in the stock market.
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