Who’s in Charge of the Market?

This past week, the GDP report showed that the economy contracted for the second consecutive quarter, putting us on the cusp of an official recession. On that news, the stock market rallied. Sometimes the market moves in the opposite direction than people think it should. Today, I will share what I’ve learned about the market and explain why it sometimes has contrarian shifts like last week.I have found that two main groups of people are the most significant influencers of the future value of stocks and the market—analysts and economists. The analyst’s job is to analyze a company’s financials and project what they believe is a fair price for a stock. The economist’s job is to analyze the economy and forecast where they believe the country is heading.There is a financial concept called the efficient market hypothesis, which says that any news (good or bad) is priced into the market as soon as it is known. When analysts or economists paint a rosy picture of the future, the market reacts positively to that news as if the outcome is almost certain.Here’s how this works. Suppose economists projected that we will experience the most robust economy we’ve ever seen—the market will increase on that expectation. Then, suppose that the future economy turns out to be strong but not as rosy as was expected—the market will decline because it had already priced in a rosier future and was disappointed.The same thing happens to individual company stocks. Analysts project how a company should perform in the foreseeable future. In most cases, the stock price adjusts when analysts release their projections. Then, if a company’s earnings disappoint expectations, the stock price will decline even if the company has record profits.Over the past six months, I have told you that the stock market has priced in a near-term, moderate recession. One of the reasons the stock market rallied after another negative GDP reading last week is that economists had expected the decline to be more significant than it was, and a bleaker economic outlook had already been priced into the market.The market doesn’t always move in the way people expect, but now you know one of the reasons for that phenomenon. Happy investing! Ü