Are Stock Prices Real Any More?

One wonders if stock prices are real.  Consider the evidence.  Due to political obtuseness, the U.S. barely avoided defaulting on its debt.  The economy continues to expand at a disappointing rate.  Employment growth is tepid.  Middle class incomes are falling, on average.  Consumers are gloomy.  The Federal Reserve Board is gloomier.  Businesses hold back on investing cash.  But, last week, the S&P 500 reached record heights.  When you encounter cognitive dissonance in the financial markets, be careful.  Every time in the past 20 years when things seemed out of whack, it eventually turned out that, in fact, they were out of whack.  In other words, if it looks too good to be true, it probably isn't true.

Could investors be wearing their stupid hats again?  Their 401(k)'s got clobbered in the 2000-01 tech stock crash, and after adjustment for inflation, stocks still haven't recovered.  Investors' 401(k)'s and homes got clobbered again in the financial crisis of 2008, and many haven't recovered from those losses.  What does it take to move up the learning curve?

Maybe, however, the problem isn't investors.  Over 50% of the trading volume in the stock markets comes from high-speed computerized trading.  This activity isn't based on human judgments.  It flows from algorithms and formulae.  Some of the computerized trading is dynamic--it changes based on what it observes in the market.  Since the activity it is often observing is computerized, we now have computers reacting to the activity of computers, which could be reactions to activity by other computers. 

When stocks were valued by humans, we had some idea of what we were dealing with.  Even if things seemed irrational or even bubbly, we could understand what was happening, albeit with a frown.  Now, with stocks being priced by "thought" processes that are impenetrable to the average investor, the market not longer reflects the collective judgment of humans.  Instead, it is an amalgamation of valuation processes that often aren't based on human judgment.  The things that people are concerned with--lousy economy, sluggish jobs growth, falling incomes, dim view of the future--may not be finding their way into stock valuations, at least not in the ways that they historically did.  If so, we can't be sure stock prices are real because we have no idea what the computers will do next.  Caveat emptor.