Finding cause and effect in the stock market is a fool’s game. There are way to many variables and there are people in the equation too. Individually, people are almost fully unpredictable. Nonetheless finding tendencies with the crowd as background may be useful.
As a case in point here is a graphic of the S&P500 from 1960 to about the present.
Ho Hum. It goes up. It goes down. It fluctuates. I should have bought in 1975 and sold in 1999.
In general, graphs of this type are misleading because the underlying reality in the 1970’s is not the same as the 1990’s, or any other time for that matter. To get ideas about the underlying reality, we need to puzzle it out a bit.
This graph might help.
The flat top from 2000 to now is just smoothing out the excess values from earlier. Eventually everything returns to the underlying fundamentals. Reversion to the mean. The stock market reflects underlying economy of long time periods.
I have added three lines to the graph above. The blue line is the old tendency line. Most of the money in the market was professionally managed then. The green line shows an inflection in 1987 and the red one another inflection in 1994. The question is what could have caused the inflections?
1994 is not all that hard to guess. I emphasize guess. 1994 saw the introduction of Netscape. The first easily useable browser. Once Netscape appeared, there was much more information readily available to everyone. Plus the internet looked like the new gold rush. 1994 is also in the midst of the introduction of exchange traded index funds. It could be any or all of these as the driving force for change. Less skilled individual investors maybe, or demand for index stocks, or pie in the sky stocks. Not much chance any will recur.
1987 took me longer to find a reason. Another guess but an interesting one.
If you are a fund manager, your governor is your ability to tolerate stress. You are, every hour of every day dealing with hunches, guesses and uncertainty. Randomness can harm you. You need to be a minute ahead of the pack. A smart trader once told me that the only way to survive is “Sell until you sleep.” Traders get more cautious as the stress builds.
What was different in 1987?
You know it better as Prozac. Introduced to market in 1987. Do you suppose traders who feel better, and maybe sleep better, buy more stock at higher prices?
The lesson is the same no matter the reasons. Stay focused on markets in general ways. Day to day details are too confusing. You cannot expect to win the fluctuation game for long. In the long run you make a fair return and for anyone under 86, the rest of your life is statistically likely to be more than 10 years.
Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.