Here are two stories about stocks that I find hard to reconcile:
Stock prices represent the market’s best guess at a stock’s future price.
Overall, stock prices tend to go up due to advances in technology.
But if stock prices tend to go up due to technology, why isn’t that already priced in?
This seems relevant to investment strategy:
The more true #1 is, the less you should expect to beat the market over the long term: lots of other people with skin in the game have worked hard to produce that best guess.
The more true #2 is, the more you might expect to beat the market over the long term: you only need to know which technologies are likely to grow, you don’t need to know better than everyone else.
As an example: if you think AI is going to accomplish big thing X, and you think the market already knows this, should you buy and hold relevant AI company stock? Or would you expect the anticipated growth to already be priced in?
Some potential answers I can think of:
The market is continually surprised by the pace of technology. (This seems unlikely to me.)
Significant technology gains are realized in private companies. Stock market indicators go up when these companies go public, but the gains are only realized by the private investors. (But we could then reframe the question as “why do index funds go up” and hit the same issues.)
Time-discounting: the market expects prices to go up, but they would rather have their money now than wait for the return and deal with volatility. As the technological gains are realized, the market expects the price to increase; individuals just can’t benefit from that given their (aggregate) preferences. Knowledge of which technologies are likely to grow is already factored in, to the point where expected growth is distributed roughly evenly across all public companies. So story #1 is false, but to beat the market, you still have to know better than everyone else. (My current leading candidate.)
Either story #1 or story #2 is false in some other way.
Question: What are good ways to think about this? What evidence do we have?
EDIT—Summary of things I got from answers/comments:
lsusr (and others) suggest that stocks going up has to do with risk. I’m still pretty confused about this one. If stock prices move to be what they need to be in order to match risk with returns, but they also move to match some measure of a stock’s actual value (in terms of dividends or otherwise), then how do those dynamics combine? https://www.lesswrong.com/posts/4vcTYhA2X99aGaGHG/why-do-stocks-go-up?commentId=BTQApZJJsGtBSHxfx
[Question] Why do stocks go up?
Here are two stories about stocks that I find hard to reconcile:
Stock prices represent the market’s best guess at a stock’s future price.
Overall, stock prices tend to go up due to advances in technology.
But if stock prices tend to go up due to technology, why isn’t that already priced in?
This seems relevant to investment strategy:
The more true #1 is, the less you should expect to beat the market over the long term: lots of other people with skin in the game have worked hard to produce that best guess.
The more true #2 is, the more you might expect to beat the market over the long term: you only need to know which technologies are likely to grow, you don’t need to know better than everyone else.
As an example: if you think AI is going to accomplish big thing X, and you think the market already knows this, should you buy and hold relevant AI company stock? Or would you expect the anticipated growth to already be priced in?
Some potential answers I can think of:
The market is continually surprised by the pace of technology. (This seems unlikely to me.)
Significant technology gains are realized in private companies. Stock market indicators go up when these companies go public, but the gains are only realized by the private investors. (But we could then reframe the question as “why do index funds go up” and hit the same issues.)
Time-discounting: the market expects prices to go up, but they would rather have their money now than wait for the return and deal with volatility. As the technological gains are realized, the market expects the price to increase; individuals just can’t benefit from that given their (aggregate) preferences. Knowledge of which technologies are likely to grow is already factored in, to the point where expected growth is distributed roughly evenly across all public companies. So story #1 is false, but to beat the market, you still have to know better than everyone else. (My current leading candidate.)
Either story #1 or story #2 is false in some other way.
Question: What are good ways to think about this? What evidence do we have?
EDIT—Summary of things I got from answers/comments:
ike points out that “why stocks go up” is at least partially an open problem known as the “equity premium puzzle”. https://www.lesswrong.com/posts/4vcTYhA2X99aGaGHG/why-do-stocks-go-up?commentId=XtR6rrdTnXJ5aJyJ6
Vladimir_Nesov suggests that as the real cost of goods goes down, inflation targeting causes other things (including stock prices) to go up in nominal price. So technology uniformly increases stock prices by dropping the real cost of goods. https://www.lesswrong.com/posts/4vcTYhA2X99aGaGHG/why-do-stocks-go-up?commentId=92kj4rYCKgFWTG2G6
lsusr (and others) suggest that stocks going up has to do with risk. I’m still pretty confused about this one. If stock prices move to be what they need to be in order to match risk with returns, but they also move to match some measure of a stock’s actual value (in terms of dividends or otherwise), then how do those dynamics combine? https://www.lesswrong.com/posts/4vcTYhA2X99aGaGHG/why-do-stocks-go-up?commentId=BTQApZJJsGtBSHxfx
Dagon points out the “greater fool theory” that stock prices might not reflect real value, and go up due to the shared expectation that they’ll go up. https://www.lesswrong.com/posts/4vcTYhA2X99aGaGHG/why-do-stocks-go-up?commentId=GAzHsKrx49XXfB5gD