One of the most irritating myths about the stock market is that daily news items explain most of the movements in the stock market. Every day you hear that the stock market went up or down because of a specific economic or political news event. Today, when the stock market tanked, with an almost immediate 300 point loss, it was blamed on the weekend revelation that the Supercommittee was not going to come up with any solution by its statutory deadline. However, any such connection is totally ludicrous.
As J. P Morgan once so astutely noted, stocks will fluctuate. Stocks will go up or down, even if there is absolutely no news. What controls the stock market and stock prices is the general expectation of the future health of the economy and companies by the world as a whole. This is not to say that news doesn't affect stock prices. But for news to affect stock prices, it must deviate from the current expectation. For example, if everybody expects that Microsoft will buy out Yahoo for $30 a share two months from now, Yahoo certainly will not be trading for $15 today--it'll be trading much closer to $30. Of course, expectations are not black and white, so current prices reflect the probabilities of certain events happening. So if Yahoo stock is worth $15 a share without takeover prospects, but there is a 50 percent chance that some company would buy them out in the near future for $30 a share, its current price would settle somewhere around 22½.
Which brings up to today's market drop being blamed on the Supercommittee's inability to come up with a budget alternative. Well, if the general expectation had been that the Supercommittee was going to be successful, and the failure to come up with an agreement would be catastrophic, then the cause and effect would be reasonable. But in fact the failure of the Supercommittee to find a solution was almost as surprising as the fact that the sun rose today in the eastern sky. Trading futures on Intrade a week ago pegged the chance of a Supercommitee agreement at 20 percent, a percentage which undoubtedly diminished during the week last week. Furthermore the lack of an agreement merely means that the default solution goes into effect, unless otherwise modified by 2013. Consequently, unlike something approaching a Congressional bailout vote with down to the wire uncertainty, this news had little to do with today's stock market action.
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