Stop Freaking Out! Here’s Why Big Stock Swings Aren’t Always Big News!
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Market volatility and denominator bias. A favorite line, you hear me say it from time to time here when making comparisons, which weighs more, a pound of lead or a pound of feathers? They’re the same thing. Well, when it comes to the stock market and how the media comes, basically covers the stock market, and especially volatile moves, and we’ve seen a lot of them over the past couple of months,
They focus on the points. How many points? my God, the markets were up 700 points. my God, the markets were down 1000 points. Well, this is what we call denominator bias. Now I remember pretty vividly the market swings that took place during the Great Recession.
I remember when the first was a TARP deal was rejected and the sell off after that. Well, let’s say the 1000 points in 2008 is not the same as 1000 points today. However, like I said, the media doesn’t care about that. Basically, there’s this thing that we like to call it.
It was actually coined by Kip Vescusi and Richard Zechhauser. It’s called denominator blindness. It’s the tendency to focus on what? The top of the fraction, not the bottom of the fraction, or the magnitude of bad outcomes, not on the total number of events from which those outcomes are drawn. So again, it’s the percentages.
people and you’re taking a look at market moves and you’ve seen obviously some very, very large market moves, but the point numbers are what actually gets the people going and makes it a hell of a lot more drastic. If you were to ask, you would ask any investor if the stock market is more volatile than it used to be, more often than not, you’re gonna say, absolutely.
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my God, moves 100 points all the time in a day. It’s no big deal. And again, I’m dating myself. Okay. A hundred point move when I started in this business, that was a massive move. It’s interesting. Even what we’ve seen the spike in volatility, the market has fluctuated far less sharply in the last three years than has been typical in the past.
100 points right now is 0.6 % change in the Dow. A thousand points, okay, that’s a 6.6 % decline. But how significant is that? Again, listen, markets, they can basically take a look at their cyclical adjusted price-earnings ratio.
Cape, which Robert Shiller came up with. stocks are higher than their historic average that there’s no doubt about that. But the reality is times are different things change. That is a great piece. And he’s actually a pretty great writer for the Wall Street Journal. I got to give credit where credit’s due. He’s been doing a pretty good job. Jason Zweig did a bit on the psychology.
of this and the thousand point drop. He said, historical data might feel as unchanging as an exhibit in a museum, but the financial past is non-stationary. As St. Augustine pointed out more than 1,600 years ago, time is a continuum. Today’s returns will be in the market’s past results tomorrow, and the long-term return changes slightly almost every day as the latest increment or decrement of performance
gets averaged into it. And again, this is one of the things that we try to get people to focus on. Again, not the noise, not the scare tactics, not the major swings, which are not as major as they used to be, but where it’s going to be down the road. The where of, well, don’t be blinded by denominators, right? Or be, yeah.
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Is that right? blind? Yeah, don’t be blinded by denominators. Watchdongon WallStreet.com.
