A great book I started reading recently is Making Sense of Chaos by economist J. Doyne Farmer. In the book, Farmer discusses his ideas for understanding economies through the lens of complexity science, which is the study of complex adaptive systems. The book referenced an interesting academic finance paper published in 1988 titled What Moves Stock Prices. The paper, authored by David Cutler, James Poterba, and Larry Summers, investigated the influence of news on stock prices.
Farmer described their work as such:
“Cutler, Poterba and Summers began by finding the 100 largest daily fluctuations in the S&P 500 index between 1946 and 1987. They then looked at the New York Times on the day after each move and recorded a summary of the paper’s explanation for the price change. The authors made a subjective judgement as to whether these explanations could plausibly be considered ‘real news’ – or at least real enough to have triggered a sizable change in stock price.”
The largest daily move in the paper’s dataset occurred on 19 October 1987 – now famously known as Black Monday – when the S&P 500 fell by 20.5%. Interestingly, there was no substantial news to explain the collapse. Farmer mentioned in his book:
“The explanations for the 20 per cent drop on October 19, 1987, were ‘worry over dollar decline and rate deficit’ and ‘fear of US not supporting dollar’. Cutler, Poterba and Summers didn’t classify this as news, and I agree. ‘Worry’ and ‘fear’ are subjective statements about the emotional state of the market that have no specific reference to external events.”
Farmer went on to mention:
“Of the dozen largest price fluctuations [shown below], only four were attributed to real news events, a ratio that they found also roughly applied to the largest 100 moves.”
In other words, as I have suspected to be the case for as long as I have been investing, stock prices are indeed more often than not driven by factors outside of the news. I find this to be an important trait of the stock market to know because if we’re constantly looking for news to explain short-term stock price movements, we’re likely to be wrong often, and this can impair our investment decision-making process.
The twelve largest daily price fluctuations in Cutler, Poterba and Summers’ dataset for What Moves Stock Prices:
- Date: 19 October 1987
- Daily change: -20.5%
- Explanation given: Worry over dollar decline and trade deficit; Fear of US not supporting dollar
- Date: 21 October 1987
- Daily change: 9.1%
- Explanation given: Interest rates continue to fall; deficit talks in Washington; bargain hunting
- Date: 26 October 1987
- Daily change: -8.3%
- Explanation given: Fear of budget deficits; margin calls; reaction to falling foreign stocks
- Date: 3 September 1946
- Daily change: -6.7%
- Explanation given: “… no basic reason for the assault on prices.”
- Date: 28 May 1962
- Daily change:-6.7%
- Explanation given: Kennedy forces rollback of steel price hike
- Date: 26 September 1955:
- Daily change: – 6.6%
- Explanation given: Eisenhower suffers heart attack
- Date: 26 June 1950:
- Daily change: -5.4%
- Explanation given: Outbreak of Korean War
- Date: 20 October 1987
- Daily change: 5.3%
- Explanation given: Investors looking for “quality stocks”
- Date: 9 September 1946
- Daily change: -5.2%
- Explanation given: Labor unrest in maritime and trucking industries
- Date: 16 October 1987
- Daily change: -5.2%
- Explanation given: Fear of trade deficit; fear of higher interest rates; tension with Iran
- Date: 27 May 1970
- Daily change: 5.0%
- Explanation given: Rumours of change in economic policy; “… the stock surge happened for no fundamental reason”
- Date: 11 September 1986
- Daily change: -4.8%
- Explanation given: Foreign governments refuse to lower interest rates; crackdown on triple witching announced
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