Don’t anthropomorphize markets

For today’s post I wanted to decry a financial markets press tactic that is as old as the markets themselves.  Namely, the media love to anthropomorphize markets, especially the stock market.  In other words, this is the tendency of reporters to ascribe human behavior to the price gyrations of stocks.

Here is an example from today’s Wall Street Journal:

“U.S. stocks wavered as investors continued to trade cautiously following last week’s rally…”

This kind of reporting is so common that it isn’t even questioned.  But why is it incorrect to do this?  The reason is that each day the “market” is simply the movement in an index of stocks.  Those indices are an artificial mechanism designed to create the appearance of singular cohesion.  We follow stock indexes because they aggregate into a single number, up or down, what stocks have done during a day.  Yet, that index is typically made up of hundreds of individual components, each of which had a unique trading pattern for the day.  In fact, each stock’s investors have their own personal reasons for trading that day.  Maybe it is in response to good news or bad news.  Maybe it’s because they are financing the purchase of a new car.  Maybe it’s because they are trying to lock in a loss for tax purposes.  Maybe it’s because their best friend recommended that they buy.  And so forth.  The index then destroys each of these individual stories into a solitary number.  Then the journalists are let loose with their adjectives and their tendency to try and make human the movement of the index.

Yet, by ascribing human characteristics to a mathematical construct we actually obscure meaning, rather than lend meaning to the movement.  The reason is that we then create a narrative for the human-like index.  That narrative frequently takes on mythological or fairy-tale like qualities.  During a bubble or a bubble-burst we hear stories of the hopes and fears of “The Market.”  Then we forget to do our analysis as we buy into a story about the market, as opposed to believing in our own analysis and reasons for investing.

The other reason I decry the anthropomorphizing of the financial markets is because it creates the illusion that absolutely everyone is trading at a given moment.  Go back up to that WSJ quote from today.  Who are the “investors” it refers to?  The implication is that everyone who considers themselves an investor is trading cautiously.  Yet, during the dot.com era I had an intern of mine (hello Matthew Schildt!) do a piece of fascinating research using stats available from Yahoo! Finance.  He captured in a single spreadsheet all of the components of the Standard & Poors 500 Index.  Then he looked at the total shares of stock outstanding for each company.  The total of those shares is the total number of possible shares that could be traded on the S&P 500 each day.  Then he tracked trading volumes over many weeks (or months, I can’t remember).  Our goal was to see just what it meant when “the market” was trading.  So what percentage of “investors” do you think were trading on a daily basis back in the dot.com era on its heaviest trading days?  5%?  10%?  What percentage of investors were trading?

The number turned out to be 0.7%!  Everyone who has heard this number was shocked.  That is such a paltry number.  So when you hear a Wall Street Journal or CNBC statement of, “Today investors bought into a strengthening market,” or something similar.  Remember, investors means just those people who are motivated to buy or sell today.  Then remember that markets don’t strengthen as a singular entity – the market is an artificial mathematical construct whose creation aggregates/destroys the singular and unique reasons for why most investors bought or sold on a given day.

Jason