Slate.com's overconfidence was entirely predictable
By Scott Sumner
People tend to be overconfident in their views. They are overconfident about their political views, their religious views, their views on global warming, even their views on sports. That’s just human nature.
And people are especially overconfident about their understanding of markets. Here’s a Slate.com article from two days ago:
China’s Stock Market Is Falling Again. This Was Entirely Predictable.
For a little while, China’s stock market seemed to be rallying from the nausea-inducing crash that wiped out a third of its value in a month. Now, it’s back to falling, albeit a little more slowly. Over the past two days, the Shanghai Composite Index is down 4 percent. Tally the ups and downs, and it’s off about 26 percent from its June heights.
There are a few reasons why shares are dipping again. But one of the biggest, as the Wall Street Journal notes, is simply that investors are finally free to buy and sell stocks like normal again. Most of them, anyway. At one point last week, trading had been suspended for more than half of all listed corporations on China’s markets.
Was the market decline entirely predictable”? I doubt it. And if it was, why didn’t Slate.com tell us it was going to happen two days earlier?
And I don’t understand the phrase “is falling again”. Why not say “has recently fallen”? Doesn’t “is falling again” subtly suggest some sort of downward momentum, likely to continue for at least a short while? But then why did Chinese stocks rise about 4% in the two days after the Slate article, to the level before the “entirely predictable” decline? And where is the entirely predictable Chinese market going next?
Although Slate.com did not predict the decline two days earlier, they did say this back on the 9th of July:
China’s stock market stopped crashing on Thursday. After a stunning four-week drop that obliterated a third of its value, the Shanghai Composite Index rose 5.8 percent, its largest one-day gain in six years. This may be a sign that that the Chinese government’s extraordinary efforts to calm investors have finally worked.
Or, it might just be a breather before the carnage starts anew.
Here’s the problem. Sooner or later, trading will have to go back to normal. And when it does, there’s a good reason to think the sell-off will start up again, since Beijing hasn’t done anything to address the likeliest culprit behind the plunge: Too many mom-and-pop investors borrowed money to buy stock, which they are now being forced to unload in order to cover their losses.
It could be the “efforts . . . worked” or it could “just be a breather”. Okay. And how did the market move after July 9th?
It went up for two straight days. Then down for two straight days. Then the Slate.com “entirely predictable” comment. Then up for two straight days. What about that was entirely predictable?
In my view
markets stock prices changes are roughly a random walk, and market movements are nowhere near “entirely predictable”, even with government distortions. Those investors still free to buy and sell would be inclined to do so at prices expected after the government meddling ceased (which is one reason I doubt that government intervention has much effect, except to the extent it increased perceived liquidity risk, or if the government is seen as planning to hold the stocks permanently.) If the government is simply trying to delay an inevitable decline for a few months, it’s unlikely to succeed, even in the short run.
I would add that the government did not intervene in the highly liquid Hong Kong market, which tends to be strongly correlated with the Chinese market. And yet that market also had a sharp price run-up, a steep decline, and then a partial recovery–just like China.
People love to say things like “The US housing bust was entirely predictable”, even when they have no explanation for why house prices in Australia, New Zealand, Canada and Britain are still at so-called “bubble” levels. Why didn’t entirely predictable crashes occur in those 4 countries?
I recommend that people ignore all predictions of the future movement of asset prices, whether it is from the media, professional economists, or Wall Street stock pickers. There is no evidence that these forecasts are useful.