Do We Know Any Better Than The Market?
by Mike Jette on Apr 24, 2020
Investors often try to predict what is next during times of volatility. There’s constant discussion over when the true bottom will hit and which investments will recover the fastest. It is tempting to try to outsmart the market by thinking about how the virus will affect major companies.
What many investors don’t realize is that the market adjusts to new information very quickly. If the market is going to go down tomorrow, it goes down today. If everyone knows it’s going down this quarter, it goes down now. For some reason this is a hard concept for many investors to understand. Simply put, the market is constantly pricing in things that are going to happen in the future.
A great example of this is the explosion of the Space Shuttle Challenger in 1986. Four major companies were contracted to produce the shuttle, one of which was Morton Thiokol. At the time of the explosion no one could figure out what went wrong. Experts quickly got to work looking for the cause, but they didn’t have an answer for the public until months later.
Meanwhile, the market seemed to figure it out right away. In the few minutes after the explosion, the price of all four companies took a quick and hard hit. But within the hour, the amount of Morton Thiokol shares being sold far outpaced the other three companies. The selloff volume was so heavy that the stock was halted on the trading floor. While the other three companies seemed to stabilize, Morton Thiokol continued to fall. By the market close, Morton Thiokol had lost significantly more than the others and ended the day down 12%.
Long story short, Morton Thiokol was eventually found liable for the parts that were defective during the Challenger launch. The company paid millions of dollars to the families of the astronauts and completely lost their reputation in the marketplace. What took the government eight months to figure out, the market had priced in within the hour.
This isn’t to say that markets are always this efficient and that opportunities don’t present themselves. The market is not always right. There are pricing discrepancies and certainly things we can take advantage of during times of market volatility. But too often we think we can outsmart the market, when really much of what we are experiencing has already been factored in.
Right now, many experts predict that the Coronavirus will continue to worsen until the end of April. We would expect markets to continue to fall as the pandemic worsens. But how do we know that those projections aren’t already priced in? Why would we own stocks when we know that the virus will get worse? Do we really know anything that the market doesn’t?
Let me reiterate that I have no idea how markets will behave in the short run. If the virus spreads faster than experts predict, I think that markets will get worse. If social distancing is very effective at slowing and controlling this outbreak, markets may improve. The move higher this week seems to be in response to a slowing in the number of new cases. Notice that I said a slowing in new cases, because we still have more total cases today than yesterday.
Bottom Line: The pandemic is projected to get worse, but we don’t know if the markets haven’t already factored this in. Markets react in advance of the economy.