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Irrelevant Ups and Downs

Man YawningThe U.S. stock market gained 2.05% on Friday, the biggest one-day gain for the S&P 500 index since early September. Of course, this comes after the same index was down 1.1% (Wednesday) and 1.4% (Thursday).

What’s going on?

Of course, no person alive knows exactly what drives the psychology of millions of investors, despite the confident analyses you read in the papers and see on cable financial news channels. Yes, on Wednesday and Thursday, some investors may have been disappointed that the European Central Bank provided only the stimulus to the European economies that it had promised—when everybody seemed to be expecting more. Analysts said that the rally on Friday was due to the encouraging jobs report issued by the Labor Department, which told us that 211,000 net jobs had been created in November, rather than the 200,000 that had been forecast.

But does any of this make sense? Stimulating the European economy means more potential buyers for American goods and potentially more euros to buy them with. Shouldn’t that cause American stocks to be MORE valuable than they were before? The jobs data, meanwhile, means there will be more competition for workers, which often leads to higher wages and correspondingly diminished corporate profits. Above and beyond that, the reassuring employment picture means that the Federal Reserve Board is now nearly certain to allow short-term interest rates to rise on December 16. Shouldn’t that cause stocks to be less valuable?

The truth is that none of these events causes stocks to change their real intrinsic value in the least, and you should be skeptical every time you hear journalists draw links between headlines and stock movements. The magnitude of the shifts should be a clue; how can a company—let alone a basket of 500 companies—be worth 2% more one day than it was yesterday? Did they all win the lottery? Did they all get caught making significant accounting errors that understated their earnings? How much more likely is it that investors have to make guesses—sometimes wild ones—as to the value of companies, getting it more or less right over time, but constantly over- and under-shooting in their daily guesses? If you follow this line of reasoning, it is helpful to note that the value of U.S. stocks, despite all this back and forth action, was essentially unmoved for the week, and pretty much unmoved for the year.

The markets may go back down this week, or they might soar. This year may or may not end with a net gain. None of that matters to your portfolio, which is slowly increasing in value to the extent that the companies you own are building value in ways that have nothing to do with the headlines. If the world comes to an end, that will have an impact on the markets that we can measure with some precision. Short of that, short-term market movements, and particularly the explanations that writers and pundits attach to them, are entertainment—and not especially entertaining at that.

Our recommendation? Go watch a movie instead.

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