Paul Krugman: Is It Momentum or Panic?

When stock prices are rising, it’s called ‘momentum investing’; when they are falling, it’s called ‘panic’.
— Paul Krugman

Economic theory isn't based on human behaviour, but on games of logic. In the economists' so-called "efficient market," prices move when new facts change investors' expectations.

But on January 4, 2000, without any notice or prompting, U.S. share prices dropped so hard that CNN called the session a “meltdown.” The Dow fell more than 3% and the Nasdaq more than 5%.

It turns out that real investors aren't entirely rational. Instead, they are driven by fear, greed, and the madness of crowds. So the market fluctuates more than it should. People sell because prices seem to be falling, or buy because prices seem to be rising. The result is a market that makes unexpected leaps in the short term.

In the short run, the market is a voting machine. In the long run, it's a weighing machine.
— Benjamin Graham

Graham’s metaphor dovetails with Krugman’s joke. Votes (the buying and selling of shares) bounce prices around. Weight (companies' earnings and dividends) settles things over the years.

Read more about Graham in our post, Ben Graham on Beating the Big Boys. Or buy one of his influential books, Security Analysis and The Intelligent Investor.

Paul Krugman's latest book is Arguing with Zombies: Economics, Politics, and the Fight for a Better Future. It's a very readable guide to the wrong-headed economic ideas that just won’t die. I also recommend his newsletter, Notes on economics and more.

Krugman has focused on writing and teaching rather than wealth building and has an estimated net worth of $5 million.

Catch up on earlier reflections at www.mydailyoracle.com, and watch for tomorrow’s note in your inbox.

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