Recent stock market gyrations illustrate one interesting phenomenon. Each time the administration promises an easing in the “trade tensions” it itself created, the stock market picks up. Every time the promises are not realized, the market drops. And the process starts again.
Today’s Wall Street Journal writes (“Stocks Turn Higher on Trade Hopes,” May 15, 2019):
Stocks erased declines from earlier in the day after Treasury Secretary Steven Mnuchin said U.S. negotiators are likely to travel to Beijing soon and reports emerged that the Trump administration is putting off a final decision on whether to impose broad tariffs on automobile and auto-part imports.
Updates on global trade policy have swung markets in recent days, with stocks rising and falling on shifting bets about the U.S. and China eventually reaching an agreement.
The efficiency of financial markets does not mean that they can predict correctly, which is obviously impossible. It only means that all available information is incorporated in buying, selling, and prices. This information includes what investors think that other investors will think and do, the so-called self-referential character of financial markets, which further changes risk into uncertainty (where no odds can be estimated, a distinction due to Frank Knight).
Investors are ordinary people, but they have skin in the game, which gives them incentives to search for information and avoid “rational ignorance” (that is, the rationality of not spending resources on information that will not help one improve one’s situation, which is typical of the voter who has only one vote).
Another way investors resemble ordinary people is their political naivety. Their incentives do not seem, at least currently, to prevent them from trusting the state, even when government spokesmen regularly mislead and manipulate them.
Politicians, on the other hand, have an incentive to lie more than ordinary individuals because the consequences of their actions are complex and unknowable by the rationally-ignorant and myopic voter, who will rapidly forget politicians’ words and deeds. (On the short memory of voters, see Christopher Achen and Larry Bartels, Democracy for Realists, which I reviewed in the Summer 2017 issue of Regulation