Monday, 14 April 2014

Graph of the week: beware of stock market charts

Observe the following two graphs (HT: Business Insider):

Source: Business Insider
The first one depicts the S&P 500 index over the past 17 years where it seems to show remarkable patterns of volatility. The pattern is basically a series of sharp increases followed by a an even steeper decline. The market went up during the dot-com bubble in the 90-ies, only to see a sharp decline when the bubble burst (the 9-11 attacks didn't help either). The Fed then lowered the rates in fear of another recession and was encouraged to help fuel the housing bubble to offset this temporary market decline. Which it did as the market again underwent several years of high returns (which was actually another bubble). Then came the crisis of 08 and the market plummeted, only to recover in the later years, primarily thanks to massive QE done by the Fed. So if the pattern continues, we could be in for another correction right about now? Right?

Wrong. Even by looking at this graph alone that would be a false conclusion given the fact that we know what caused the market to slump in 2001 and 2008 (or at least we think we know). We don't expect any of the same bubbling adversities today, at least not until the money multiplier is still below 1 and the velocity of money is at its historical low as well. 

Source: Business Insider
Looking at the second graph the pattern is obviously much different. The past 17 years, in terms of the long run, seem to represent a stagnating trend, similar to the one after the Great Depression, or better yet to the one in the 70-ies. This could be indicative of a different type of shock that has hit the economy (a technological shock which didn't uncover the inefficiencies in the labour market until 07-09), but it could also not mean a thing. There is a good way to explain each of the downturns and surges in particular. Looking at just one historical segment of the curve can be more off-putting than helpful.  

Here is the lesson from this: If you wanna make money on the stock market, beware of making investment decisions just via technical analysis (predicting future movements based on historical trends).

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