When you ask students what the “market” is, they often respond enthusiastically with a description of the stock market. The explanation usually goes something like this: it is where one can purchase a piece of a company and share in its profits. This is a great place to start, but the stock or equity market is a small part of the “market.” I think it should be described as one instrument section in an orchestra – maybe the most appealing and easiest to learn – but just one section. As I have written about in a previous post, the bond market is many times larger than the equity market, but one would never know that when they pick up a corporate finance textbook. The bond market is heavily traded among institutional investors and not easily observable to students. To further complicate matters, outside of equity and bond markets, we have hundreds, if not thousands, of other financial instruments including swaps, letters of credit, warrants and commercial paper to learn about. There are thousands of arrangements that represent the transfer of some type of financial asset. It is quite a large orchestra and therefore it is difficult to make out which sections are making the music not sound very pleasant.
The other difficulty of teaching and analyzing the “market” is that these instrument sections do not play on the same stage. There are a variety of exchanges and clearing options available to market players and then there is the lion’s share of activity that goes on outside of exchanges directly between investors. The more complexity that is added to this imaginary orchestra, the more difficult it is to analyze what the “market” is doing.
However, there are a lot of tools to try and grasp the well-being of this complex market symphony. The Chicago Fed has a National Financial Conditions Index (NFCI), which is a weighted average of over 100 measures of financial activity published weekly. The index measures risk, liquidity, and leverage in money markets, debt and equity markets, as well as traditional and shadow banking systems. The latest index published showed little change in the condition of financial markets for the week ending October 9. There are other interesting ways to look at how our imaginary orchestra plays as well, such as behavioral approaches that are much more nuanced than indices. For an example of this, check out this site to get a feel for this type of analysis: https://www.marketpsych.com/.
It is important that we all expand how we present the “market” to students as it is critical to finding new and more complete ways to analyze what the “market” is doing. Symphony orchestras are impressive. When one has a trained ear, the different instrument sections can sound like they are speaking to one another. Perhaps, the modern day finance student needs to learn equal parts art and science to be able to more fully analyze the “market” in the future.