From the New York Times today's Opinion by Dr Justin Wolfers -...

From the New York Times today's Opinion by Dr Justin Wolfers - Prof of economics and public policy at the University of Michigan

They’re unpredictable, volatile and prone to sharp emotional swings. They have short attention spans and find change difficult because they are frequently scared of new things or overly enthusiastic about them. They’re impulsive, demand attention and throw tantrums when they don’t get what they want.

I’m not describing toddlers but traders.

This week’s financial market meltdown had a lot in common with a toddler tantrum. The catalyst was Friday’s moderately disappointing jobs report, combined with the Federal Reserve Board’s failure to cut rates in anticipation of those disappointing numbers. Yes, markets can often signal a faltering economy, but there are better signs elsewhere. A nuanced reading would note that the Fed signaled a willingness to cut rates, that July’s employment numbers may have been distorted by Hurricane Beryl and that the rise in unemployment reflected a spike in temporary layoffs.

But toddlers see best in simple terms. So too do traders, who spat out their pacifiers and revolted, driving stock prices down by 3 percent on Monday. They also drove long-term interest rates down sharply in anticipation of Fed rate cuts. The VIX — a measure of how fearful the market is of future market gyrations — rose on Monday to worrying levels.

A good tantrum doesn’t just annoy parents, it also draws the attention of onlookers. Some drew parallels with the 1987 stock market crash, and others described the Fed as “behind the curve.” Jealous siblings tend to add fuel to tantrums, and indeed, former President Donald Trump posted on Truth Social that “stock markets are crashing” and “jobs numbers are terrible.” The Republican National Committee tried to make #KamalaCrash trend. (Just so you know, even July’s anemic employment growth was higher than the average through the Trump presidency, which was hit by big losses at the start of the pandemic. Also under President Trump’s watch, the S&P 500 experienced larger daily declines 21 times.)

When things aren’t going well for toddlers, they’ll instinctively reach for Mom or Dad. For traders, it’s the Fed they look to. Calls grew for Dad — a.k.a. the Federal Reserve chairman — to find a Band-Aid to make it feel better. Some demanded the Fed cut interest rates outside its usual cycle, something that usually occurs only during a bona fide emergency, like a banking crisis. Others urged it to cut rates by a bigger chunk than usual. Parents sometimes don’t respond well to such demands. Neither did the Chicago Fed’s president, Austan Goolsbee, who noted sternly that “there’s nothing in the Fed’s mandate that’s about making sure the stock market is comfortable.”

Discomfort rippled out from Wall Street to Main Street. Because it can be hard to track what occupies people’s minds, I like to follow the number of times people search Google for “recession.” This index rose sharply in recent days, to levels roughly comparable to the global financial crisis of 2007-09, which was a meltdown of enormous consequence.

Parents know that sleep and food can make everything better. And by Tuesday morning stocks rebounded, long-term interest rates reversed course and the VIX fell back to earth. As lunchtime ended, markets were mostly back to normal.

And just like that, the brief recession of Aug. 5, 2024, was behind us.

So what can we learn from it?

It’s easy to make fun of market gyrations — Paul Samuelson, one of the greatest economists of the 20th century, once quipped that the stock market has predicted nine out of the past five recessions — but they can also provide valuable insight. After all, buying stock in a company is effectively betting on that company’s economic future. This makes stock prices one of our few truly forward-looking indicators. They’re easily spooked but also highly attuned to risks. Just because you don’t see the monster under the bed doesn’t mean there’s not one there.

For those of us tracking the economy, it’s worth keeping an eye on financial markets. But markets shouldn’t command all of our attention. Keep your eye on the hard economic numbers that describe our present reality. Right now they are telling a much happier story with fewer reasons to worry than the narrative that’s been coming from Wall Street this week.

https://www.nytimes.com/2024/08/07/opinion/why-financial-markets-are-like-toddlers.html