What’s Baked Into the Market? And What Does That Even Mean?
What’s Baked Into the Market? And What Does That Even Mean?
(Bloomberg Businessweek) -- Pundits who wouldn’t know baking soda from baking powder love to talk about what’s “baked in” to the market. Is a Biden victory baked in? Is a second wave of Covid-19 cases baked in? In the past week alone, Bloomberg News and Bloomberg Intelligence used “baked in” in stories about a Rhode Island construction company’s 401(k) plan, the Reserve Bank of India’s monetary policy, and the earnings forecasts of United Internet AG.
“Baked in” is just traders’ lingo for “expected.” If the stock market collectively expects former Vice President Joe Biden to win the election, then prices of stocks have already adjusted to reflect that expectation. You, the clueless latecomer, can’t make any money by betting on a Biden victory because others have beaten you to it. Markets are, in a word, efficient. In baking terms, the hypothetical Biden victory isn’t a new ingredient. It’s already in there with the eggs and flour and baking powder (or is that baking soda?).
“Priced in” and “discounted” are synonyms that also appear liberally in financial news stories and Wall Street analysis. The idea behind all of them is that to make money, it’s not enough to know what will happen. You also have to know whether other investors already expect it.
“As an investor, the most important thing at any moment in time is not the issues, it’s how much the consensus has discounted those issues,” says James Paulsen, chief investment strategist for Leuthold Weeden Capital Management LLC in Minneapolis. “I spend a good deal of my time looking into whether there’s under- or overreaction to issues.”
Market pros don’t always focus on the same things the general public and news media do, Paulsen says. The power of today’s low interest rates is underappreciated by the public, he says. In contrast, he says, “To me, even now, Trump getting sick and being in the hospital is much less of an issue than the coverage it gets.”
Sam Stovall, chief investment strategist at CFRA Research, says “a sharp second round of the Covid virus and the adverse effects that it might have” aren’t baked into the stock market right now. If there is a second wave, he says, stocks would probably sell off.
Detecting the conventional wisdom, i.e., what’s baked into stock prices, “is as much an art form as it is a science, despite what many say,” says Quincy Krosby, chief market strategist at Prudential Financial Inc. What makes the task even harder, she adds, is that the market can change its collective mind in a hurry. The initial reaction of the markets to Donald Trump’s surprise victory in the 2016 election was negative, but within hours, she says, “the market had a change in attitude and hasn’t looked back since.”
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