Sunday, May 2, 2010

Markets are always right

The PBS series NOVA has an interesting show this week. Called "Mind over Money," it summarizes the debate between rationalist and behavioral economists over the role emotion plays in financial markets. http://www.wgbh.org/programs/programdetail.cfm?programid=16

The idea that markets always act rationally and that the market price is always the correct price is at best a tautology. At worst, a fraud.

Unregulated markets are prone to mistakes. Most market trends overshoot the optimum price in both directions. Stocks go up, then come down then go up. The 9 am price is not the noon price is not the closing bell price. When the price of a stock drops 40% in a day, as occasionally happens, it is hard to argue that both the opening and closing prices were right, and  the fundamental value changed by 40% in the course of a trading day.

More likely either the opening price was too high, or the closing price was too low, or, most likely, both were wrong.

Markets are not omniscient. Social costs may well not be included in determining the price, buyers and sellers may be mistaken in their understanding of the stock's or commodity's future. Someone may be manipulating the market.

Will Rogers said the key to making money in the market was "Buy a stock and sell if when it goes up. If it goes down, don't buy it."

My rule is that if someone tells you the price of stocks, housing, pork bellies, t-bills or tulips can't ever go down, he is either a fool or thinks you're a sucker.

When people believe a price can only go up and never come down, then the market is valuing optimism over common sense. Not a good sign.

In the meantime, I know a guy named Ponzi who will make you a millionaire selling you international postal orders.

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