The Stock Market Is Not Broken. It’s Just Having a Midlife Crisis
A
Comprehensive (and Slightly Unhinged) Guide to the Recurring Anomalies That
Make Financial Experts Question Their Life Choices
Let us
begin with a confession. The stock market, despite what your well-tailored
mutual fund manager would have you believe, is not a rational machine. It is
not a finely tuned engine of economic efficiency. It is, in fact, a chaotic
carnival of human delusion, calendar-based superstition, and the occasional
software glitch—all dressed up in a three-piece suit and pretending to be
serious.
As one
trader recently put it, “The market is weird. Stocks are swinging about as
though there’s a full-blown crisis, while the S&P 500 is just 2% from its
high.” Weird, indeed. But weird in ways so predictable that academics have
spent decades cataloguing them. These are the stock market anomalies—recurring
patterns that make a complete mockery of the Efficient Market Hypothesis,
which, as Warren Buffett once dryly observed, would leave him “a bum on the
street with a tin cup if the markets were always efficient.”
The
Efficient Market Hypothesis, for the uninitiated, is the academic theory that
stock prices reflect all available information because investors are rational.
To which Charlie Munger reportedly responded by calling it “bonkers,” adding
that it was “an intellectually consistent theory that enabled them to do pretty
mathematics” but whose “fundamental assumption did not tie properly to
reality.” In other words, it looks great on a whiteboard and terrible in
an actual market crash.
Take the January Effect, for instance. Every
year, like clockwork, small-cap stocks tend to outperform in January. Why?
Because investors sell their losers in December for tax purposes and buy them
back in January. It is financial spring cleaning, except nobody actually cleans
anything—they just move the mess around. As the saying goes on Wall Street, “As
goes January, so goes the year.” Of course, this “effect” has been
disappearing for decades, which means it now works only when nobody believes it
works, which means it probably still works but nobody can prove it, which is
precisely the kind of circular logic the stock market thrives on.
Then there is the Monday Effect, where stock
returns on Mondays are mysteriously lower than on Fridays. Apparently,
investors spend their weekends marinating in bad news and existential dread,
then take it out on the opening bell. As Vijay Kedia, the ace Indian investor,
once quipped about market psychology, “In a bull market, a beginner becomes an
analyst, chartist, advisor, economist, and genius in 7 days. In a bear market,
a genius becomes a beginner in 7 hours.” Monday mornings, one suspects,
are where that seven-hour transformation typically begins.
The Halloween Effect—or as the cool kids call
it, “Sell in May and go away”—suggests that stock returns from November to
April are significantly better than from May to October. Why? Perhaps because
summer vacations make investors lazy. Perhaps because the weather is too nice
to stare at a Bloomberg terminal. Perhaps because someone in 1972 made this up
and it just stuck. Nobody really knows. But every October, investors start
sweating, thanks to the October Effect, a perceived anomaly rooted
in the crashes of 1929 and 1987. One market wag on social media captured the
collective sentiment perfectly: “When you see Nifty crash, remember: gravity
works everywhere, even in the stock market.”
If you think calendar anomalies are bizarre, wait until you
meet the fundamental ones.
The Value Effect says that cheap
stocks—those with low price-to-earnings ratios or high book-to-market
values—tend to outperform over time. The Size Effect says
small companies beat large ones. The Momentum Effect says that
stocks that have been going up will keep going up, which is the financial
equivalent of saying a train that is moving will continue moving until it
derails. As Richard Driehaus, the father of momentum investing, put it, “I
believe that more money can be made by buying high and selling at even higher
prices. I take exception to the idea of buying low and selling high.” Buy
high, sell higher. It is so stupid it just might work.
Then there is the Post-Earnings Announcement Drift
(PEAD) , where stocks drift in the direction of an earnings surprise
for months after the announcement. If a company beats expectations, the stock
keeps rising. If it misses, it keeps falling. This should not happen in an
efficient market. But markets are not efficient. Markets are, as Seth Klarman
put it, “driven by human emotions: greed and fear.” Greed and fear, it
turns out, do not read financial reports carefully. They just follow the crowd.
That brings us to the behavioral anomalies. Herding is
when investors follow the crowd into bubbles. Overconfidence is
when they think they can time the market. Noise trading is
when they buy based on rumors, memes, or a vague feeling they got from a TikTok
video. As William Feather memorably observed, “One of the funny things about
the stock market is that every time one person buys, another sells, and both
think they are astute.” Both cannot be right. But both can be very, very
confident.
Perhaps the most entertaining anomalies are the ones that
make absolutely no sense whatsoever.
Take the Index Inclusion Effect: when a stock is
added to a major index like the S&P 500, its price goes up. Not because the
company got better, but because index funds are forced to buy it. It is the
financial equivalent of being invited to a party and suddenly becoming more
attractive.
Or the “Wrong-Stock” Rally, where investors
confuse one company with another and buy the wrong one. During the pandemic,
people conflated Zoom Video with a tiny company called Zoom Technologies,
causing the latter’s stock to skyrocket. It was a “mistaken identity” rally,
and it was glorious. As Philip Fisher lamented, “The stock market is filled
with individuals who know the price of everything, but the value of nothing.”
And then there is the Technical Glitch Anomaly,
where a software bug causes a stock to trade at a completely wrong price for a
few seconds. It is corrected quickly, but for those few seconds, someone
somewhere either made a fortune or had a heart attack.
Harsh Goenka, the RPG Enterprises chairman, recently summed
up the market’s mood with a Bollywood analogy: “Markets aajkal full drama mein
hain — ek din Salman Khan, agle din Uday Chopra. Sensex ko gazab ke mood swings
ho rahe hain.” One day a blockbuster hero, the next day a punchline. He
also offered this piece of investing advice during a downturn: “Jab prices
girti hain, quality stocks clearance sale mein milti hai — lekin log panic mein
underwear bhi bech dete hain!” When prices fall, quality stocks go on
sale—but people panic and sell their underwear too. The investing hero, he
said, is the one who buys a portfolio, not popcorn.
Sanjeev Prasad of Kotak Institutional Equities took a
different route, populating the market with an entire zoo of metaphors. There
are frogs having a swell time in a magical pond that keeps replenishing itself,
oblivious to the rising temperature. There are pigs rolling in lucre, smug
about the rising water levels. There are vultures circling, and
apes—commentators and analysts—who “sit in their usual arboreal hauteur, rarely
descend to the floor of the jungle, and drop overripe fruit periodically.” It
is a vivid picture, and deeply unsettling.
So what do we make of all this? The market has more than 150
documented anomalies. Some work, then stop working, then start working again
when nobody is looking. Some are real, some are statistical noise, and some are
just excuses for traders to feel smart.
Norman R. Augustine probably put it best: “If stock market
experts were so expert, they would be buying stocks, not selling advice.” And
John Maynard Keynes, who knew a thing or two about both economics and human
folly, delivered the final blow: “Markets can remain irrational longer than you
can remain solvent.”
The anomalies keep recurring because humans keep recurring.
We sell in December and buy back in January. We chase momentum and then reverse
it. We panic on Mondays and celebrate on Fridays. We follow the herd, ignore
the fundamentals, and convince ourselves we are geniuses—until a bear market
turns us back into beginners in seven hours.
The market is not broken. It is just having a midlife
crisis. And like all midlife crises, it is predictable, expensive, and
endlessly entertaining to watch from a safe distance.
So goes the market, so goes the madness. Buy portfolio,
not popcorn. And for heaven’s sake, don’t sell your underwear.
#StockMarketAnomalies, #BehavioralFinance, #InvestingHumor, #SellInMay, #MarketMadness
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