Why the Stock Market Is Overrated

Image by 272447 from Pixabay

Many are baffled about the recovery in the stock market over the last one month, even when the economy is suffering and has bleak prospects. Experts are trying to make sense of this disjunction. Some are saying that the market has run up ahead of the fundamentals. Others are anticipating a sharp recovery with the lifting of the lockdown.

The stock market has been made out to be what it is not. To see the stock market as some robust mechanism that predicts what will happen in the real world or that reveals a picture otherwise hidden is a mistake. The market has been erroneously given more respect than it deserves, when it is a random mechanism at best, at least in the short run. 

Investors and analysts tend to make sense of a company’s performance or a policy decision from how the stock market reacts to it. Some call it a “discounting mechanism.” Others consider it as a crystal ball that helps them look into the future. The US president boasted of the new highs in the stock market as a signal of his successful management. The abrupt fall in the market shakes governments, which start wondering if what they did was indeed right.

By bludgeoning a stock, the market gets control of the fate of a live company. Because the stock has been beaten up, there must be something wrong with the company, investors wonder. This turns into a self-fulfilling prophecy. A free-falling stock price can be lethal for finance companies and those that have taken up debt or have high promoter pledging. Not surprisingly, the top management rushes to soothe the market’s nerves before much damage has been done. It also uses the share-price performance as a gauge of its competence.

All this is a mistake. The stock market is not an efficient mechanism. You can’t always trust its ups and downs to have any real-world implications. In the short run, traders determine its course. Stocks move up and down because there are vested short-term interests. With the onset of algo trading and other automated ways, the frenzy in the market will only increase. That won’t mean things are changing dramatically. Reading too much into market moves can only dilute your focus and returns. 

At best, the stock market is a buy–sell mechanism. Its main job is to provide liquidity. If you entrust it with any more responsibilities, that’s a recipe for a life of anxiety and pessimism.