What goes up must come down

Stock prices early last week were collapsing all over the world. So exciting! So alarming!

But, uh, what does it mean?

The hard-line answer is, nothing at all. Here’s Nassim Nicholas Taleb’s famous critique from “The Black Swan” of journalists’ perverse need to attach narratives to random market movements:

“One day in December 2003, when Saddam Hussein was captured, Bloomberg News flashed the following headline at 13:01: ‘U.S. treasuries rise; Hussein capture may not curb terrorism.’

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Whenever there is a market move, the news media feel obligated to give the ‘reason.’ Half an hour later, they had to issue a new headline. As these U.S. Treasury bonds fell in price (they fluctuate all day long, so there was nothing special about that), Bloomberg News had a new reason for the fall: Saddam’s capture (the same Saddam). At 13:31 they issued the next bulletin: ‘U.S. treasuries fall; Hussein capture boosts allure of risky assets.’ ”

Still, when stock prices fall more than 10 percent over a couple of days, it might be something more than just random fluctuation. We should be skeptical of explanations, but that doesn’t mean all of them must always be wrong.

There are two main classes of explanations of market behavior. One sees stock prices as reflecting or even predicting economic reality; the other focuses mainly on the dynamics of markets themselves.

For last week’s market fall, most of the former explanations had to do with China. Investors are worried about the slowing Chinese economy and what that slowdown will mean for global economic growth and Chinese political stability – and for the prospects of companies, such as Apple, that do a lot of business there.

These are all reasonable fears, but the market’s apparent reaction to them doesn’t add up to any kind of reliable economic forecast.

“The stock market has predicted nine of the last five recessions!” economist Paul Samuelson exclaimed in 1966, an analysis that has held up pretty well since. Financial markets have a clear tendency to overshoot, which is why people spend so much time trying to figure out why and how they do so.

Where does that leave us? Financial adviser and market pundit Josh Brown argued recently that stocks simply have to go down occasionally so they can go up.

The only reason stocks can go up is because they can also go down. It is this risk that keeps investors in check and that keeps people from paying an infinite amount of money for shares in a business.

That’s an appealingly Zen explanation. Stock prices fell early last week because if they didn’t, markets wouldn’t work. Thanks, stock prices! •

Justin Fox is a Bloomberg View columnist who writes about business.

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