Ep.97 - 3 Lessons I Learned From a Wrong Market Prediction

📸 IG handle: DollarSenseLA

My Original Prediction

On March 1st, in my Ep.92, I had predicted the market would be turbulent most of March. Then the disappointing Q1 earnings season in mid-April would contextualize how bad things had become, thus triggering a market sell-off. See below for the prediction I put together.

As it turned out, I was wrong and the market has been on a recovery path since late March, now S&P 500 is well above 2900, just 13% shy of its February peak. What happened?

After a lot of reading, pondering, and repeated reflection, I’ve summarized my mistakes into 3 lessons, all of which were not taught in classroom Economics.

Lesson 1: The Market Acts Like an Opinionated Person Who Says He’s Data-Driven

We all know at least one person who preaches making data-driven decisions, however, what the person really does is to use data to validate his existing assumptions, therefore making data-driven decisions on “select” data, only when the data support his thinking. As it turned out in the last 2 months, this is how the stock market works as well, like an opinionated person, who is data-driven, but on “select” data.

This is quite different from what we all learn in Econ 101, which is that the market will absorb ANY new information, and price it in.

What I learned in the last 2 months is that, when given a choice of multiple conflicting information, such as a fast-climbing unemployment rate, and a glimmer of hope with reopening of a certain state at the same time, the market can choose to ignore the bad news and choose to pick the good news, no matter how much more distant and less concrete one of them is.

Lesson 2: The Federal Reserve is More Powerful Than Anyone Could Imagine

I knew the Federal Reserve was powerful. In fact, I took a course on monetary policy in 2009, the perfect time to see it in action back then. However, the lesson I took away at the time was that the Federal Reserve was unable to prevent a market crash, let alone a recession, no matter what they did in 2008. It only prevented a recession from turning into a depression.

However, this time around, the Federal Reserve had done it all at unprecedented speed and scale. I personally think the speed of announcing what it will do mattered as much as the actual doing. In fact, Jerome Powell admitted it in today’s FOMC conference, stating the immense immediate power from its announcements.

Specifically, the Main Street Lending Facility was announced in March to help all sorts of companies directly, but still not operational a month later. In fact, no corporate loans have been made at all as of 4/29/2020, but it’s already improved corporate lending, because it has boosted the market’s confidence, so companies now can find private lenders, without having to come to the Fed.

If anything I learned, it is that, if the Fed says it will save the economy, people will believe it.

Lesson 3: The Stock Market is All About Confidence - Fake it Until You Make It

The fact that the stock market has almost fully recovered while the actual economy is headed towards the worst crisis since the Great Depression, suggests that the stock market does not represent the actual economy. Instead, I see the stock market as a barometer of America’s confidence as a whole.

In fact, here’s how data plays a role. Hard facts and data help build confidence, however, any hints or forward-thinking can also help build confidence. For example, you don’t need to have the same amount of wealth as Warren Buffet to feel as confident as him. The same applies to the stock market. The actual economy does not need to be as strong as it was in order to feel more confident, thus reaching the same level.

To ensure that we feel more confident, the Fed, in my opinion, has played the most important role, in projecting confidence. It almost feels like fake it until you make it. The Fed is helping everyone feel like things will be fine soon, hence things are becoming fine, as least in the stock market.

Do I Think The Stock Market Will Dip Again?

Still possible. However, it would have to come from some exogenous variable outside of the Federal Reserve’s control. For example, it could be another oil shock, which is outside of America’s control, or a collapse of China’s economy, which is outside of the Federal Reserve’s control, or even a systemic market failure triggered by a foreign giant on a similar scale of Lehman Brothers or Enron. It could be SoftBank in this case, but also some other black swan event.

Now I feel more and more strongly if anything happens domestically in the U.S, the Fed would just throw money at it. Though it’s a loan, not a grant, the Fed can still bring any firm back to life in the short term.