The Dow's Jump Proves Markets Are Irrational

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

The goal of a functioning market is to incorporate new information into prices as quickly and efficiently as possible. Yet the fast-paced flow of news often merely sets up short-term whipsaws that can trap the unwary. The recent moves in the Dow Jones Industrials (DJINDICES: ^DJI  ) provide an obvious example, as fears concerning the government shutdown and the impending breach of the debt-ceiling limit sent short-term traders scurrying for the exits, leading to triple-digit declines for the Dow in several recent sessions. Yet today, even the faint possibility of a potential solution sent the market back up again, with the Dow rising 207 points as of 10:50 a.m. EDT to break above the 15,000 level once more.

Yet one source of market irrationality is trying to find explanations for short-term moves in news events that have broader implications for companies' business prospects. For instance, Boeing (NYSE: BA  ) has gained 2.5%, rising along with the Dow as the aerospace giant with substantial ties to the government stands to benefit from an end to the government shutdown. Yet that explanation necessarily has to dismiss any impact from news concerning more potential technical problems with the company's 787 Dreamliner aircraft, which have required two Japanese 787s to turn back to departure airports and have prompted a Norwegian airline to ground its second Dreamliner after the first showed hydraulic and electrical faults. It'll take time for investors to evaluate those events rationally to determine whether they pose a true threat.

Still, some stocks could benefit from the irrationality of consumer responses to the government's well-publicized moves to prevent financial disaster. Both Visa (NYSE: V  ) and American Express (NYSE: AXP  ) have enjoyed gains of more than 2%, recovering most of their losses from drops earlier in the week. The shutdown has raised concerns about potential consumer reactions to an extended period of lost wages for government workers, despite the fact that furloughed workers have in the past received back pay for their missed time. A solution won't undo the economic damage that has already been done, although it would limit future problems and could help Visa and AmEx if consumers don't pull back on spending as much as some economists anticipate.

Finally, be careful of irrationally thinking that small signs of progress mean the potential for disaster is gone. The S&P Volatility Index (VOLATILITYINDICES: ^VIX  ) , widely seen as a measure of fear in the market, has dropped more than 12% today as investors dismiss the possibility that the Washington impasse will continue. That complacency could prove short-lived if it turns out investors are pinning too much hope on these positive signs. The better choice is to stay ever-vigilant for potential threats while not allowing them to dominate your longer-term strategy.

One Thing You Can Always Be Rational About
It's hard to be irrational about cold hard cash in your pocket, and that's why dividend stocks are so appealing to many investors. Get the best ideas our analysts have to offer by checking out The Motley Fool's brand-new special report, "The 3 Dow Stocks Dividend Investors Need." It's absolutely free, so simply click here now and get your copy today.


Read/Post Comments (1) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Add your comment.

DocumentId: 2676715, ~/Articles/ArticleHandler.aspx, 4/18/2014 10:00:44 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement