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Coronavirus can make markets as scared, volatile or illogical as the rest of us



Or maybe you think the market’s dive is a crazy overreaction. You can recognize that covid-19 is a potentially deadly bug without expecting it to knock 25 percent off of everyone’s living standards — or even the roughly 4 percent of gross domestic product lost between 2007 and 2010.

I do expect a contraction; I don’t expect it to be followed by the sort of years-long malaise that we experienced during the financial crisis. But I also don’t think that’s what the stock market is trying to tell us. The truth is, in times like this, the markets — like the humans who participate in them — aren’t so much trying to predict the distant future as manage the present.

In part, the market drop reflects concern about profits, not about economic growth. When GDP shrinks even a little, corporate profits tend to shrink a lot. Businesses’ fixed expenses don’t drop as fast as their revenue. So a relatively small decrease in GDP might mean a big drop in future corporate earnings.

In addition, market prices tend to reflect views about the near term — not the distant future. This is not because of “short-termism,” a sin that CEOs and investors are frequently, and not really justly, accused of committing. It’s just that the further out your predictions are, the more likely those predictions are to be overtaken by unexpected events — say, by the appearance of a deadly disease no one expected four months ago.

Conversely, an investment that’s going to deliver a lot of money soon is inherently more valuable than one that would deliver you the same amount of money far in the future. Therefore, stock prices are heavily weighted toward near rewards rather than far-off ones.

What all this adds up to is that when investors expect the economy to shrink somewhat, and very soon, they react by making stock prices fall a lot, right now. That happens even if they also expect the economy to eventually recover nicely and make them rich.

There’s one more factor worth noting in the current downturn: Sometimes, almost no one wants to buy securities. That is true especially during periods of high uncertainty, when investors decide it would be wise not to do anything much until they can figure out what the heck is going on.

When a bunch of investors all simultaneously park their money on the sidelines, prices fall — often by a lot. That doesn’t mean that anyone believes that future financial returns all suddenly dropped by that amount. It just means that most people aren’t buying. So the people who really must sell — for example, to cover a margin loan — are competing to be among the lucky few who manage to sell their stocks and bonds to the very limited pool of buyers.

Everyone, including sellers, may recognize that buyers are paying less than the assets are worth in the long term. But in moments such as these, that long-term value is not what’s driving the price. Eventually, investors will get a better feel for where we’re headed and swoop in to scoop up bargains. That can, however, take some time.

Of course, over years and decades, stock and bond prices are related to their expected returns in the form of interest, dividends or capital gains. That’s why you shouldn’t panic and sell off your retirement fund right now. But over short periods of global crisis, when everyone is just trying to figure out what the heck will happen next, markets aren’t efficient in that narrow sense. They can be just as scared and volatile and apparently illogical as the rest of us.

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