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Bloopers and Blunders: CNNfn’s
Reasoning for the Surge in the Dow
- "Buoyed
by reports of record mutual fund money pouring
into Wall Street in January, blue chip stocks
bolted fearlessly into record territory Monday.
The Dow Jones industrial average posted a
decisive gain, rising 58.53 to 5600.15, to its
sixth record in a row. Economically sensitive
stocks, or cyclicals, led the way."
"Stocks
were widely higher, powered by investors pouring
record amounts of money into mutual funds. The
Investment Company Institute, a mutual fund trade
group, said investors put $24.5 billion more into
stock funds in January than they removed."
(CNNfn Feb. 12, 1996)
Answer. Even if you believe
in the "weak form efficient market", i.e., stock prices reflect/discount
all past information, this explanation would not make any sense. Since
the announcement itself is not "inside information", one would
have expected the news to have been already discounted in stock prices.
Moreover, on January 29, 1996 the WSJ reported that "in
the past several weeks, an increasing number of portfolio managers have
started deploying resources more aggressively overseas, and individual
investors have started to pour money back into international and global
mutual funds."
2.
"Technology stocks sat this rally out as investors
gobbled up cyclicals instead. The normally lively Nasdaq
composite was up a tame 0.78 to 1095.38."
Ans. You
should also question why was the effect primarily on
"cyclical stocks." Was there more money
pumped into these stocks? Yet even more puzzling is
the fact that technology stocks did not participate
in the surge. Using the CNN argument, this would
suggest that investors did not pour in money into
technology stocks!
The Wall
Street Journal, on the other hand, quoting
different analysts, provided three alternative
explanations for the record surge. One explanation
had to do with an influx of cash from money managers
who had believed that the market "was due for a
correction." It still does not explain why
suddenly these money managers changed their mind
about the imminence of a correction! Here is an
interesting second explanation quoting a trader:
’This type of bull market is tough to describe,
but it’s kind of like there’s been this
collective decision that the thing will just keep on
going.’ Maybe this analyst is referring to the
popular "herd mentality" phenomenon. The
third explanation did have an economic rationale,
attributing the upsurge to a lowering of expected
inflation as reflected in falling gold prices.
So which
explanation is correct? Probably all contributed to
some degree, but CNN’s heavy emphasis on money
pouring into Wall Street is probably over
exaggerated.
Relationship
Between Gold and Stock Prices: A Closer Look
Q. So what
influences gold prices?
Ans. The
price of gold is heavily influenced by
investors’ sentiments about future inflation. In
general, worries about the erosion of real value
(purchasing power) of financial assets drive a
significant number of investors toward purchasing
precious metals. Thus, an increase in demand for gold
would cause an increase in its price. Using this
explanation, we observe that gold prices did go down
on the day in question. Thus, other things remaining
equal, we can make the inference that the cause of
the drop in gold prices must have been due to
investors lowering their expectations about future
inflation.
Q. What does
gold price have to do with stock markets?
Ans. Lower
expected inflation means that the cost of capital
(cost of borrowing/financing) to a company is lower.
A lower cost of capital, other things remaining the
same, increases the value of cash flows, thus the market
value of the company stock.
By Alex Tajirian
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