Pavlov’s dog refers to a series of experiments by Russian physiologist, Ivan Pavlov, which discovered classical conditioning during his research on dogs’ digestion. He accidently stumbled upon the conditioning reflex by noting that repeating a bell ring prior to feeding eventually stimulated salivation in the animal even though no food was present.
It is now a well-accepted theory and, as we know now, obviously applies to more than just animals.
Take the stock market for example. Decades back the markets reacted to positive economic news, plain and simple. Good earnings and a healthy employment market drove investors into stocks. Conversely, bad economic news generally eroded investor confidence and the market would sell off.
A Pavlovian response for sure. As the years clicked off and with the advent of a central monetary authority, the Federal Reserve (FED), weak markets brought about the idea that a proactive FED could use a variety of monetary tools and mitigate severe market downturns.
Although certain economic theories argue that capitalistic markets cannot be manipulated into submission, other economists believed that careful implementation of FED actions could successfully manage economic downturns.
Those actions-such as the raising or lowering the cost capital, (known as interest rate adjustment) , buying government debt (allowing an increase in deficit spending), and a variety of other actions, are designed to make money either cheaper or more expensive-which can influence investor behavior.
Some economists argue, however, that these FED actions will only exasperate economic turbulence. Others believe the FED had found the holy grail for preventing market catastrophe by using the tools at their disposal.
Regardless of which side of the economic aisle one is on, the FED has apparently come to the point where it constantly tries to micromanage the economy, much like a ship negotiating an ocean full of land mines.
Economies are constantly in a state of flux. There are many moving parts of a complex industrial society. As a result, bad news and good news hit in varying degrees and at varying times. Reading the proverbial tea leaves of where an economy might be headed therefore is no easy task.
Despite this tricky environment, some argue that the FED thinks that it is omnipotent.
That belief is somewhat self-evident as it is constantly implementing their various policies at any sign of trouble.
The FED’s tools are powerful and supercharged. Any one adjustment can make significant changes to both the stock market and the economy under it.
These ongoing movements by the FED have occurred for decades. Market participants have learned, like Pavlov’s dog, that when economic news hits the newswires, the FED will act by turning one or more of these powerful economic knobs to either juice or starve the markets.
This anticipation of FED action on even the slightest piece of economic news causes the market to move in the opposite direction of what was once regarded as rational.
Investors now think that bad news means the FED will act to juice the markets and so they buy stocks. Conversely, good economic news might cause the markets to fall in anticipation of FED action in the opposite direction. Good economic news may mean inflation is building so the FED tightens the money supply and starves the markets to harness rising prices
The anticipation of FED action is now arguably a major factor in markets on whether investors hit the buy or sell button.
An example of this was last week when a negative employment number came out and the markets rose thinking the FED will act to stimulate the economy, which would be good for stocks later down the road.
Decades ago, a bad jobs number would have likely led to a market sell off. Not so today apparently.
There is more to this story that I haven’t included here because of the lack of space but hopefully you get the picture.
The bottom line is bad news might be good news for stocks and good news just might be bad for stocks,
Kind of crazy I know and, unfortunately, it makes negotiating the stock market just that much more difficult.
“Watching the markets so you don’t have to”
(end)
(As mentioned, please use the below disclaimer exactly) THANKS (Regulations) This article expresses the opinion of Marc Cuniberti and is not meant as investment advice, or a recommendation to buy or sell any securities, nor represents the opinion of any bank, investment firm or RIA, nor this media outlet, its staff, members or underwriters. Mr. Cuniberti holds a B.A. in Economics with honors, 1979, and California Insurance License #0L34249 His insurance agency is BAP INC. insurance services. Email: news@moneymanagementradio.com.
