Why It Isn’t Important If Markets Are Right Or Wrong
Are market prices right or wrong?
Market watchers and participants can be forgiven for asking this question as over the past year, the West has lurched from Covid Wave 1 to Covid Wave 2, lockdown to reopening and then new lockdowns followed by renewed lockdowns.
They have gone from V-shaped optimism to whatever letter can be used to describe the economic trajectory of: massive drop, rebound for a while, plateau for a shorter while, and drop again.
Yet financial markets all over the world continue to trade with unshakeable optimism. The clearest indicator that such optimism isn’t what market participants deem to be within the “acceptable” range is the re-emergence of the word ‘Bubble’ in the media.
So, are markets pricing assets correctly?
Well, it depends.
If one views markets as having to be a somewhat accurate reflection of the economy, then yes, markets are absolutely bonkers and are priced wrongly.
However, if one steps out of mainstream narratives that tie economic performance to market performance, and views markets as driven by the emotions of market participants instead, then markets aren’t right or wrong.
Its participants are simply exuberant.
How does this matter?
When viewing markets from this perspective, whether a market is right or wrong is an irrelevant question. Simply because for a market to be correct/incorrect, it has to be correct/incorrect relative to something else, which in the mainstream view, is the economy.
If one steps out of the “prices are either right or wrong” dichotomy and sees the market for what at its core it really is – a bunch of people making bids and offers, one can see that humans, and hence their emotions, are right in the middle of it.
Navigating price moves in the market now becomes a matter of gauging human reactions to headlines/data points.
This is in contrast to the mainstream way of interpreting headlines/data points, then coming to a conclusion on how markets should react to them.
This way of thinking about markets can be especially helpful when everything is being furiously bid up across major asset markets, as being in tune with how bullish the markets are can help to keep an individual trader running with the trend.
Furthermore, keeping track of how emotions gradually change from Fear of Missing Out to just plain Fear, and hence from bullish to bearish, can help in making the decision to exit longs, and depending on the individual, maybe even enter into new short positions.
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