My entire career, I’ve heard that stock markets are a forward-looking mechanism. According to the theory, markets anticipate the future based on all the data that everyone has. Furthermore, market prices now reflect where the economy will be at some point in the future. If that’s true, then why do we see phrases like “better than expected” or “underestimated.” (See articles below.) In my opinion, sometimes markets are wrong. We just don’t know it at the time.
Why do markets get it wrong? Because we are the markets! We get too optimistic / pessimistic. We are placing trades based on our analysis. The movements in the markets are caused by people. And sometimes, we the people get it wrong.
How does knowing that help us manage money? It’s part of diversification. As a beginning point, we diversify by asset class. We also diversify by strategy. We employ many levels of diversification, but one method is to diversify away from our expected outcome. Most of the time, we will have an opinion and that opinion will be based on hard evidence and extensive analysis. Now it’s time to show some humility, and ask, “What if we’re wrong?” Because we might be.
June jobs report: US economy adds better than expected 4.8 million payrolls, unemployment rate falls to 11.1%
Angela Merkel fears economic crisis is being underestimated in EU
Risk of Distress for Small Business Is Underestimated
“Credit markets aren’t fully pricing in the impact the pandemic-related shutdown will have on small and medium-sized businesses.”
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