Had the market instead gone up on April 20, commentators would simply have cited as causes the numerous optimistic statements in Greenspan’s address, i.e., “deflation is no longer an issue,” “pricing power is gradually being restored,” inflation is “reasonably contained,” labor productivity is “still impressive,” etc. There were, in fact, no — zero, none — negative statements about markets, the economy or the monetary climate in his address, which is why commentators — in order to maintain their belief in news causality — had to resort to such an elaborate rationalization to “explain” the day’s price action.
But wait. The market went up the next day, April 21. Let’s see what the explanation was then: Appearing this time before the Joint Economic Committee of Congress, Greenspan reiterated that interest rates “must rise at some point” to prevent an outbreak of inflation. But he added that “as yet,” the Fed’s policy of keeping interest rates low “has not fostered an environment in which broadbased inflation pressures appear to be building.” Analysts took that to mean the Fed might not be in such a hurry to raise short-term rates, the opposite of their reaction to his testimony to the Senate Banking Committee on Tuesday. — The Atlanta Journal-Constitution, April 22, 20046
We read that Greenspan “reiterated” his comments; in other words, he said essentially the same thing as the day before, yet investors “reacted” to the statements differently and did “the opposite” of what they had done the day before.
We know that this argument is false. How do we know? We know because once again we take the time to look at the data. Here is a 10-minute bar graph of the S&P 500 index for April 20 and 21. On it is shown the time that Greenspan was speaking. Observe that the market fell throughout his speech on April 21. It rallied after he was done. So his speech did not make the market close up on the day. It’s no good saying that there was a “delayed positive reaction,” because that’s not what happened the day before, when stocks were falling throughout the speech and for the rest of the day thereafter. Such ex-post-facto rationalization is common but never consistent. The conventional presumption of causality demanded an external force that made the market close up on the day, and, as usual, it manufactured one. An article that put the two days’ events side by side reveals how silly the causal arguments are:
NEW YORK — Stocks ended higher Wednesday despite Federal Reserve Chairman Alan Greenspan’s acknowledgment that short-term interest rates will have to be raised at some point. The gains came a day after stocks had sold off sharply when Greenspan said pricing power was improving for U.S. companies, sparking inflation fears. — USA Today, April 22, 20047
One interviewee stated the (false) conventional premise: “Wall Street was in a less hysterical mood than yesterday with Fed Chairman Alan Greenspan being more expansive in his view of the economy,” i.e., the news changed investors’ mood. The socionomic view is different: People’s mood came first. Greenspan’s words did not make people calm or hysterical; people’s calm or hysterical moods induce them to buy or sell stocks, and then they rationalize why they did. Since there is no difference in the news items on these two days, our explanation makes more sense. It is also a consistent explanation, whereas news excuses are typically contradictory to past excuses and the data.
Those offering external-causality arguments, by the way, include economists and market strategists, people who supposedly spend their professional lives studying the stock market, interest rates and the economy. Yet even they barrel ahead on nothing but limbic impulses, sans data and sans correlation, because it seems to make sense. It does so because most people’s thinking simply defaults to physics when analyzing financial events. But when we take the time to examine the results of applying that model, we find that it is not useful either for predicting or explaining market behavior.
Another interesting aspect of financial rationalization is that in fact there is virtually never any evidence that people actually bought or sold stocks for the reasons cited. The fact that people actually sold stocks on April 20 or bought them on April 21 because of these long chains of causal reasoning is dubious at best. Had you asked investors during the rout why they were buying or selling, would they actually have cited either of these convoluted interest-rate arguments? I doubt it. Most people buy and sell because the social moods in which they participate impel them to buy and sell. A news event, any news event, merely provides a referent to occupy the naive neocortex while pre-rational herding impulses have their way.
This is what’s happening: When news seems to coincide sensibly with market movements, it’s just coincidence, yet people naturally presume a causal relationship. When news doesn’t fit the market, people devise an inventive cause-and-effect structure to make it fit the day’s market action. They do so because they naturally default to the physics model of external cause and effect and are therefore certain that some external action must be causing a market reaction. Their job, as they see it, is simply to identify which external cause is operating at the moment. When commentators cannot find a way to twist news causality to justify market action, the market’s move is often chalked up to “psychology,” which means that, despite the plethora of news and ways to interpret it, no external causality could even be postulated without exposing an overly transparent rationalization. Few proponents of the physics paradigm in finance seem to care that these glaring anomalies exist.
Read again carefully the newspaper excerpt quoted above. If you at some point begin laughing, you’re halfway to becoming a socionomist.
A Model That Cannot Predict Financial Events Let’s ask another question of our believers in the cause-and-effect physics model of finance. What was the cause in August 1982 of the start of the strongest one-year rally in stocks since 1942-1943? (Was it the bad news of the recession? No, that doesn’t make sense.) What was the cause in early October 1987 of the biggest stock market crash since 1929? (Don’t spend too much time trying to figure this one out. An article from 1999, twelve years later, says, “Scholars still debate the reason why” the stock market crashed that year.8)
Can you imagine physicists endlessly debating the cause of an avalanche and feeling mystified that it happened? Physicists know why avalanches happen because they are using the right model for physics, i.e., physics, incorporating the laws and properties of matter and physical forces. The crash of 1987 mystifies economists because they are using the wrong model for finance, i.e., physics. They are sure that the crash was a reaction, so there must have been an external action to cause it. They can’t find one. Why? Because they are using the wrong model of financial causality.
