Why the Share Market Goes Up or Down

Last week, Wall Street was topped and tailed by heavy losses.

On Monday, the Dow fell 450 points and when the final bell rang on Friday, the Dow had plunged 572 points.


‘…steep losses as trade worries and continued weakness in popular tech stocks sparked selling on Wall Street that pushed the broad market back into correction territory, the Nasdaq into the red for the year and the Dow down…’

USA Today

Or, there’s this reason

‘Stocks plummet as tech, Amazon lead broad selloff; Nasdaq negative for 2018’

Market Watch

But during the week, the US was (apparently) in recovery mode.


‘Global equity markets edged higher on Tuesday amid a bright outlook for corporate earnings, while the U.S. dollar rose as concerns eased over a continuing China-U.S. trade spat’

The Globe and Mail


‘The escalating trade battle between the US and China initially cast a deep shadow over global stock markets although Wall Street staged an impressive turnaround and European equity indices ended well off the day’s lows.’

Financial Times

One day the prospect of a US­­–China trade war is the reason to hit the sell button, then next day it’s not worth getting too bothered about.

In 2017, the tech sector was the market darling. This year the love affair with Silicon Valley has cooled…a little.

Facebook, Google, Amazon et al are facing more scrutiny over the handling of our personal data.

The prospect of tougher Government regulations is making investors a little jittery.

Each day we’re given reason/s as to why points are added or subtracted from the index tally.

But don’t be alarmed. Apparently these short term ‘lumps and bumps’ in the market are no reason to get too concerned about what happens to your ‘hard earned’.

‘Why you should stay calm when markets get volatile’.

This was the title of an article, written by a financial planner, published on Fin24.

The headline caught my attention because history tells us that there are times when you DO NOT want to stay calm.

Like in September 1929 OR when an unsinkable ship hits an iceberg OR when a long established Wall Street bank goes bust.

Sometimes a heightened sense of concern is warranted.

This extract from the article was somewhat correct…

‘The problem is that emotions and investments do not easily mix. Emotions, especially fear, usually cause investors to make irrational decisions which they later regret.’

I say ‘somewhat’ because the first sentence is absolutely correct.

But the second sentence — fear causes investors to make irrational decisions — is only one side of a two sided position.

This is typical of industry spin…there’s never a bad time to be in the market.

What about ‘greed’ causing people to make irrational decisions they later regret?

Investors who took out margin loans in 2007, to invest in a ‘sure thing’, are most definitely ruing the day they made that decision. They lost their life savings (and in some cases, their homes) in a matter of months.

Agreeing to invest in such an ill-fated strategy (borrowing to invest in a market that HAS performed well above its historical average) could only have happened in an atmosphere of elevated social mood…greed was in the air.

Forecasting those good times — indefinitely — into the future is the undoing of most investors. Life repeatedly tells us that good and bad times rarely last forever…yet when it comes to investing we consign those life lessons to the memory bin. 

So why does the share market go up or down?

The reason why the share market goes up or down in the long term has very little to do with ‘trade wars’ or ‘tech stocks’ or ‘higher earnings’ or ‘terror attacks’ or ‘interest rates’.

These are the symptoms NOT the cause.

Markets are driven by social mood…our collective state of mind.

The best barometer of where we’re at on the emotional scale of fear to greed is the Shiller PE 10 — Cyclically Adjusted Price Earnings.

The following chart — dating back to 1880 — tracks the multiples investors have been prepared to pay for a $1 of earnings on the US share market.

US share market 09-04-2018

Source: Multpl.com
[Click to enlarge]

The long-term average is around 15…let’s call this the rational level.

Since 1910 — just before the Federal Reserve came into being and started tinkering with the economy — the market has spent most of the time either above or below the line of rationality. Proving that when it comes to investing, more often than not, we are irrational.

Extreme cases of ‘above and below’ represent when society has been gripped by greed or fear.

The period before and after 1929 highlights how social mood can change abruptly.

In 1929, investors were prepared to pay a multiple of 30 for a $1 of earnings…supreme optimism of what the future was going to be.

The mood changed abruptly in October 1929.

A few years later, investors were only prepared to pay a multiple of five for the same $1 of earnings…and that 83% contraction in social mood (from 30 to five) pretty much explains the reason for the heavy losses suffered during The Great Depression.

Excessive optimism was replaced by an extreme in pessimism.

The further the multiple moves away (up or down) from the rational level, the more you can expect there to be a change in social mood.

Mathematicians call this ‘reversion to the mean’.

In not-so-psychological terms it’s called ‘coming to your senses’.

The current market reading is the second-highest in history…only bettered by that period of ultra-optimism in the late 1990’s.

And look what happened after 2000…eventually the social mood returned — albeit briefly — to the rational level.

The irrationality of central bankers — trying to cure a debt crisis with more debt — is what prevented social mood from plunging to depression levels…at least for now.

People have been lulled into a false sense of security — a handful of academics have convinced society that they’re more powerful than the market.

This sadly misplaced faith has taken optimism to a level where history tells us that only bad things can happen.

Yet, we are told to ‘stay calm’.

Tune out to the day to day noise of why markets are moving one way or the other.

Stand back and look at the bigger trend that’s causing this volatility.

The US market is seriously over-valued due to a peak in optimism. Eventually that bubble will burst. And when it does, the limitations of the control central bankers can exert on markets will be exposed.

If history is a guide, in a few years’ time that blue line will be down in the sub-10 zone…resulting in losses exceeding 65% or more.

Stay calm? Hell no.

Be concerned and act while people still think the past is going to be the future.


Vern Gowdie,
Editor, The Gowdie Letter

Vern Gowdie has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser (IFA) magazine as one of the top five financial planning firms in Australia. He has been writing his 'Big Picture' column for regional newspapers since 2005 and has been a commentator on financial matters for Prime Radio talkback. His contrarian views often place him at odds with the financial planning profession. Vern is is Founder and Chairman of the Gowdie Family Wealth advisory service, a monthly newsletter with a clear aim: to help you build and protect wealth for future generations of your family. He is also editor of The Gowdie Letter, which aims to help you protect and grow your wealth during the great credit contraction. To have Vern’s enlightening market critique and commentary delivered straight to your inbox, take out a free subscription to Markets and Money here. Official websites and financial eletters Vern writes for:

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