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Psyched out

An electronic stock indicator displays Tokyo’s Nikkei 225, which lost 327.98 points on Aug. 12. (Associated Press/Photo by Ken Aragaki)


Psyched out

What can explain the summer stock market swoon?

Aug. 11 wasn’t a day that will go down in infamy, but it sure changed the course of the summer. China surprised investors by devaluing its currency, and the U.S. stock markets haven’t been the same since.

The fact that economic problems in China roiled America’s markets is odder than it may sound. Although Apple or McDonald’s may depend on vast new markets in China, U.S. exports to China are small overall. According to the U.S.-China Business Council, U.S. sales to China totaled $120.8 billion last year—real money in absolute terms, but less than 1 percent of the GDP.

The stock market could have been reacting to expectations of future business with China, as The New Yorker’s James Surowiecki speculates. Even if China is a small trading partner now, many American businesses have their eye on China for future expansion. The currency devaluation, and China’s ludicrous-seeming efforts to prop up its own markets by issuing orders to buy in the days that followed, suggested that China isn’t quite ready for prime time. Those future markets in China may be farther off than we thought.

The stock market reaction may also signal concerns about emerging markets more generally: Problems in China may be a sign that emerging economies in Asia and elsewhere are continuing to struggle.

But I have a much less sophisticated theory for the market turmoil. As one whose retirement savings are largely in mutual funds, I’ve watched happily (even smugly, at times) as the markets climbed ever higher. But it seems to me, as to many others, that the years of zero interest rates at the Federal Reserve have created a stock market bubble. Investors have bought stock because bank accounts and the other investments have not offered any return.

When markets inflate like a balloon, nearly anything can look like a needle. Investors may have been looking for a reason to flee the markets, which China’s turmoil gave them. Psychology may have been as important as fundamentals.

In my line of business, teaching corporate law, the suggestion that psychology influences the stock markets would have been heretical two decades ago. According to “efficient market theory,” the share prices reflect all publicly available information about the company in question and are the best estimate of the company’s value.

The wild swings in the markets in the past few years have raised serious questions about the validity of efficient market theory. Debate even among scholars is sufficiently robust that the 2013 Nobel Memorial Prize in Economics went both to Eugene Fama, a pioneer of efficient market theory, and to Robert Shiller, a longtime critic.

One thing both sides agree on is the danger of trying to time the market. Many of us think we can read the signs of the times and quickly pocket a nice profit as a result. But ordinary investors nearly always get burned when they try to do this.

A few days before Aug. 11, my wife and I actually talked about taking some of our money out of the stock market, based on my bubble theory. In the end, we didn’t. As the markets dropped, I thought about scrounging up a few dollars to put into the market. But I remembered the follies of market timing and didn’t do that either.

In 20 years or so, when I’m ready to retire, I’ll let you know how it worked out. In the meantime, I’ll stick to writing about the markets, rather than trying to beat them.