This blog post examines how people’s beliefs and expectations in the stock market become self-fulfilling prophecies that drive prices, and explores the impact of rumors, news, and psychology on the market.
Why “Buy on rumors, sell on news” is difficult
Stock market movements can sometimes be extremely volatile. While human hearts are said to be as unpredictable as swaying reeds, the stock market can exhibit even more elusive patterns. Yet, looking beneath this volatility reveals that stock prices ultimately move based on people’s choices. Prices rise or fall because people are willing to buy at high prices or sell at low prices. Consequently, stock price movements often appear irrational, and it is not uncommon for people’s expectations to diverge significantly from expert forecasts. Furthermore, this pattern of expectation formation extends beyond individual stocks, influencing the entire financial market and the broader macroeconomy.
Self-fulfilling Belief: When Belief Becomes Prophecy
In the stock market, the entities determining a specific company’s stock price are those willing to buy and those willing to sell. Even if a stock price is already high, if more people are willing to buy it, the price can rise again. Let’s examine this process in more detail.
Generally, if a company is good, the number of people wanting to buy its stock increases, and the stock price naturally rises. But what if the company isn’t necessarily good? Even so, the number of people willing to buy that company’s stock at a high price can increase, and when that happens, the stock price actually rises. In other words, the direct force driving stock prices upward is not the company’s performance itself, but rather people’s beliefs. These beliefs can be shaped by official news like earnings reports, but they can also be formed without clear justification. If rumors spread that a company will become a blue-chip stock in the future, its stock price may rise regardless of whether this is true.
British economist John Maynard Keynes once likened this aspect of the stock market to a beauty contest. This analogy emphasizes that anticipating what others will judge as beautiful matters more than one’s own judgment. For this reason, beliefs formed in the stock market function as ‘self-fulfilling prophecies’ once they become sufficiently widespread. When a sufficient number of people believe a stock price will rise, that belief becomes reality even without sufficient evidence, and the belief itself becomes a prophecy. While well-founded beliefs tend to persuade others more easily and spread faster, in reality, even beliefs with insufficient grounds often spread among people.
Taking it a step further, once a specific company’s stock price begins to rise, even those who didn’t trust the company may jump in to buy shares. Seeing the upward trend, they join the buying frenzy with the goal of quickly purchasing now, holding until the price rises further, and then selling for short-term profit. Particularly since 2020, not only in South Korea but also in the U.S. stock market, there have been repeated instances where a specific company is classified as a so-called “theme stock” and its stock price skyrockets in a short period. This phenomenon, regardless of personal belief in the company, results in even larger stock price fluctuations. This happens because when people actively buy in, others judge that following suit is profitable.
This principle is not limited to the stock market. It applies equally to all asset markets, including real estate and virtual assets. Consequently, people’s motivations have shifted in a different direction compared to the past. Previously, if a seller emphasized, “This product is truly excellent,” buyers often responded with suspicion: “If it’s that good, why are you selling it at such a low price instead of charging more?” However, individuals holding financial assets now actively promote the merits of their holdings.
This is because they want many people to buy that asset, which will then drive up its price. Consequently, asset markets are flooded with voices blending hope and outlook. Often, those claiming a particular stock or apartment is promising are actually stakeholders who own that asset and stand to benefit directly from its price rise. While their words may carry genuine personal hope, it’s difficult to view them as the result of cold, hard analysis.
Conversely, among those predicting falling apartment prices, many hold the strong conviction that “apartment prices must fall for society and the economy to function normally.” Furthermore, there are actual cases where experts or insiders pointing out problems with specific stocks or virtual assets face personal attacks or threats from those holding those assets. This makes it increasingly difficult to publicly express a sell opinion on specific assets.
Consequently, the asset market has become a mix of expert analysis and non-expert voices, making it harder to discern reliable information. Exploiting this situation, stock manipulation scams persistently occur: spreading false information, investing initial capital to buy stocks and artificially inflate prices, then selling holdings for profit once prices rise sufficiently.
The saying “Buy on rumor, sell on news” is logically sound. It implies that since stock prices have already largely reflected the news by the time it’s officially reported, one must buy before that to profit. However, blindly trusting baseless rumors and investing large sums carries an equally large risk of significant loss. Therefore, when investing substantial money, one needs to understand financial statements and learn to analyze accounting information to independently verify the validity of such rumors.
The Stock Market, Macroeconomics, and Human Psychology
Generally, when the economy improves, the stock market also rises. However, by the time it becomes clear that the economic situation has noticeably improved, the stock market has often already risen significantly, limiting further price increases. For this reason, what is actually important is not the figures themselves after economic indicators are released, but rather how people anticipated them before the release—that is, what the market expectations were. If the released economic indicators are not significantly different from market expectations, the stock market tends to react relatively calmly. However, if they deviate from market expectations, a major shock occurs. For this reason, the stock market tends to move ahead of macroeconomic indicators and also exhibits greater volatility.
One of the best examples illustrating this trend is central bank benchmark interest rate adjustments. Generally, when interest rates rise, corporate funding conditions deteriorate and households also find it harder to borrow money, which acts as a negative factor for the stock market. The benchmark interest rate is typically discussed for adjustment roughly once a month, and each time it has a significant impact on the market. Consequently, market participants attempt to interpret various information to anticipate the central bank’s stance and sentiment in advance. The central bank also strives to send certain signals and explain the overall direction before implementing policy, to avoid causing excessive shock to the market. This is a measure to allow market participants to predict the central bank’s moves to some extent, thereby reducing abrupt turmoil.
Depending on the situation, the same economic indicator can have entirely different effects based on prevailing market expectations. Generally, a low unemployment rate signifies robust economic activity and is interpreted as a positive signal for the stock market. However, during periods like 2022 when high interest rates were firmly maintained, a low unemployment rate announcement was instead perceived as a signal that inflationary pressures remained significant. This heightened the likelihood that the central bank would continue its tightening policy. Consequently, low unemployment figures sometimes acted as negative news for the stock market. In this macroeconomic environment, various economic indicators interact through different channels. Even identical news can form differing expectations depending on overall economic conditions, potentially influencing financial markets in opposite directions.
The Psychological Game of Households, Corporations, and Central Banks
Household consumption and corporate investment decisions are also heavily influenced by psychology. Consumption levels vary based on each household’s financial situation, and consumer sentiment is affected by unemployment rates and stock/real estate prices, making it difficult to deviate significantly from the overall trend of economic indicators. Simultaneously, consumer sentiment is significantly influenced by media reports and social sentiment.
Meanwhile, corporate investment decisions, such as large-scale facility expansions or factory construction, are heavily dependent on management’s judgment and resolve. When the economic climate is unfavorable or overall economic uncertainty increases for any reason, such investment decisions can easily be delayed or canceled. Consequently, in situations where investment sentiment is depressed, policies focused solely on tax cuts are unlikely to quickly restore investment confidence.
Once inflation begins, workers, facing fixed wages, will demand higher wages if they anticipate sustained price increases. Consequently, wage increases can lead to higher costs for businesses, potentially creating a pathway where inflation is reinforced once again. While the causes of inflation are diverse beyond wage factors, policy considerations to block this wage-driven pathway are also necessary.
For this reason, the argument that central banks must respond strongly with high interest rates from the initial stages when inflation occurs gains traction. If the central bank fails to demonstrate sufficient commitment to price stability, people may come to accept high inflation as the new normal. Consequently, the risk increases that expected inflation will entrench actual inflation. The U.S. Federal Reserve’s very rapid and substantial increases in its benchmark interest rate in 2022 can be understood within this context, and as a result, inflation showed signs of moderating to some extent in 2023.
While it’s often said that no government can consistently beat the market, this isn’t necessarily always true. When governments and central banks respond with strong policy resolve and consistency, markets can indeed retreat or change direction accordingly. The bold high-interest-rate policy adopted by the U.S. in 2022, which significantly altered the overall economic environment in a short period, is a prime example of this.
Thus, financial markets and the macroeconomy operate through a complex interplay of rational expectations and irrational behavior, cold-hearted projections and personal hopes. Within this structure where these elements mutually influence each other, accurately predicting the future is nearly impossible. However, understanding the impact of psychology and expectations on the market allows for a more multidimensional view of macroeconomic trends, thereby reducing the likelihood of significant losses.
