PoliBlog has an insightful post on the possible economic and political impact that would follow from the Dow getting back above 10,000:
While I am hardly saying that if the Dow hits 10k or more (and stays there) that that guarantees any particular outcome in the 2004 elections, can anyone argue that it wouldn’t help President Bush? Can anyone make the argument that a falling or stagnant stock market doesn’t help the Democrats? The election will turn on multiple factors, and the economy is always one them. So, good economic news, especially good economic news that is widely disseminated and fairly easily understood, certainly helps the party in power.
The problem is that it is not clear the Dow will stay above 10,000 in the near term. The WSJ (sub. req'd) is reporting on how 10,000 has emerged as a psychological barrier:
It sounds odd to some rationalists, but the Dow Jones Industrial Average has had a problem with the number 10000 .... Whenever the Dow has reached the 10000 level, it has run out of steam, sooner or later. The blue chips first surpassed 10000 in 1999, and eventually got as high as 11722.98 before succumbing to a bear market and falling back. Since that fizzle, the Dow industrials have moved past the milestone again and again. In all, they have surged above 10000 a total of 18 times, based on the average's closing value, only to lose momentum and fall below again on a later day. It makes no rational sense that a big round number like that should be a barrier, and yet...
As a quasi-rationalist, how can I square this evidence with my general belief in the efficient capital markets hypothesis (ECMH)? Easy.
ECMH's fundamental thesis is that, in an efficient market, current prices always and fully reflect all relevant information about the commodities being traded. In other words, in an efficient market, commodities are never over- or under-priced. The current price is an accurate reflection of the market's consensus as to the commodity's value. A hard rationalist version of the ECMH would claim that investor psychology is irrelevant. The hard rationalist version, however, is almost certainly wrong. Research in cognitive psychology suggests that investor idiosyncrasies do not always cancel one another out. Instead, investors sometimes act like a herd all running in the same direction, which can produce pricing errors. Large speculative bubbles that appear out of nowhere and crash without apparent reason are the most visible form of this phenomenon.
There is considerable evidence that markets adapt to investor irrationality over time, however. If investor irrationality produces pricing errors, it becomes possible to profit by taking advantage of them. At one time, for example, the capital markets showed a systematic bias against small cap firms. As a result, it was possible to earn abnormal returns by investing in a portfolio weighted towards small caps. Over time, many investors did so, including a substantial number of mutual funds that specialized in small cap investing. As a result, the small cap anomaly gradually faded to the point at which it was no longer possible to systematically beat the market by investing in them. Interestingly, however, the Dow 10,000 barrier has elicited a market adaptation that -- at least in the short run -- is likely to reinforce investor irrationality:
In practical terms, short-term investors have learned to make money by speculating that the market will gyrate when it hits key psychological points. ... People use index futures and other devices to bet that stocks will sag as they hit a symbolic barrier.
These bets create downward pressure that reinforces investor skepticism. Fortunately, there is evidence that experienced traders can learn their way out of the irrational behavior patterns that lie at the bottom of so many market anomalies. Herd behavior, moreover, is a fairly fragile thing. Introduction of credible new information can have a cascade effect, in which market opinion changes almost instantaneously. Enough good economic news therefore should eventually overcome the psychological barrier and let the Dow get back above 10,000, just as the Dow eventually managed to stay above 1,000.
