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Over the years listening to market pundits, I noticed a kind of inconsistency – a sort of cherry-picking if you will – with how market prices and stock market moves are communicated to the public. Before delving further, I need to introduce two concepts: 1) efficient-market hypothesis, and 2) anchoring.

Efficient-market hypothesis, or EMH for short, asserts that asset prices reflect all available information. Essentially, under this theory, the current price of a single share of Starbucks Corp. (Ticker: SBUX) already reflects what is known, even possibly what is unknown under a stronger form of EMH. Further, the theory holds that stock prices react instantly to new news. The implication here is that a stock picker is unable to profit based on certain things it might know about Starbucks. For example, if the stock picker scans Starbucks’ financial statements and notices revenues are growing faster than its competitors, the price of the coffee chain’s shares already reflects this observation, so there is no way to profit from this information. Another example is in the case of Starbucks announcing a new sugar-ladened, ultra-colorful, and sure-to-be hit beverage. Any hopes of profiting from this information are dashed, as the price of Starbucks’ shares would have instantaneously adjusted to account for this new delicious concoction.

As you can imagine, this theory is not widely embraced, especially by those whose paychecks rely on them “beating the market”, which, on a risk-adjusted basis, is not possible to do, assuming EMH is true. The purpose of this post is not to defend the validity of EMH, but to simply show that it appears to be widely accepted, even if only selectively, by those who claim they disagree with it.

The second concept I need to introduce is anchoring, which is a tendency of individuals to place more emphasis on an initial piece of information (the “anchor”), which is used as the focal point to make other decisions. For example, if I show you a bottle of pop that costs $100, then show you another that costs only $10, you’re likely to treat the second bottle as cheaper, even though a completely rational person (whatever that is) would objectively deem the second bottle to be expensive.

Now with these definitions out of the way, let me point out the type of inconsistency that is peddled far too often and left unchallenged in the financial media. We don’t have to go back very far to pick out a good example. In February 2020, the S&P 500 Index reached an all-time high. The apparent consensus at the time, at least among the “smart-money”, was that markets were too frothy and were due for a pull back. Of course, plenty of investors disagreed and were glad to carry the index to new heights. But, the point I am trying to illustrate is that plenty of investors from both sides agreed that the current level of the S&P 500 was incorrect, plus or minus. They are implicitly rejecting EMH by positing there is a way of profiting from this apparent mispricing, i.e. take risk off the table if you believe the market is frothy, or load up if you think the market eventually goes to 4,000.

Fast forward to today. In your rear-view mirror, you see that the market delivered a gut wrenching sell-off, dropping 34% in a matter of days, only to recover most of what was lost. You see that the S&P 500 is still down from the levels it was trading at on December 31, 2019 or at its all-time February peak. A wild ride, most wish never to embark on again.

What has been the reaction of the financial media? The consensus appears to be clear. Markets climbed much too fast and are projecting too quick a recovery. Based on what you might be asking?

Well, because markets returned an eye-popping 37% return since its March low.

But, what makes the March low so special?

I call foul, as you cannot have it both ways. I argue that pundits are implicitly treating the March low as some “correct” value. In a period of chaos and record breaking volatility, the markets somehow managed to deliver a discrete, efficiently obtained, sliver of truth, by which we can compare all subsequent irrational movements. Moreover, add to this the psychological tendency of anchoring now that we have a “bottom” and we have the perfect mental mindset to begin to panic when markets begin to move away from this level.

I am not arguing that markets are or are not ahead of themselves. I am simply wondering what the pundits would be saying today if the S&P 500 had simply fallen gradually from the February high to where we find ourselves today. At the time of writing, the S&P 500 is down approximately 10% from its February peak. So, imagine a string of 3% declines, not small daily moves, which coincided with the terrible jobs data that we recently received. Would pundits be so quick to label the market as overheated?

Admittedly, they would likely point to the high market multiples the market is trading at as evidence of over valuation, but I doubt this would get the same air time.
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