Why Has The Stock Market Fooled You?
The common presumption in the market is that a news event will cause a move in the market. And, since we have all seen the market move sharply when a news event is announced, the assumption is that the substance of the news event will certainly provide the directional bias for the market move.
But, those that follow the market closely know this is clearly not how the market really works. We have often seen markets move in the completely opposite direction one would have expected based upon the substance of the news itself. So, how do we resolve this seeming conundrum?
I propose that it is much more accurate to view the news event as a “catalyst” rather than the “cause” of a market move. This is true of any news event upon which the market reacts. Unfortunately, because investors can sometimes align the substance of the event with the directional action of the market, they assume that the news is the “cause” of the directional action. But, this is nothing more than adoption of the logical fallacy that correlation equates to causation. In order for them to maintain this fallacy, they must ignore all the many times the substance of the news does not align with the directional action of the market.
We have seen many recent examples where the strong market move was in the opposite direction based upon assumptions made about the substance of the underlying news. Recently, we have seen strong reactions after the election or after the Fed raising interest rates in both the metals and equity markets which were opposite of the expectations held by most based upon the substance of those news events. In fact, how does one who maintains the standard “causation” theory reasonably explain how the stock markets exploded higher after the Charlie Hebdo attack in France?
In a 1988 study conducted by Cutler, Poterba, and Summers entitled “What Moves Stock Prices,” they reviewed stock market price action after major economic or other type of news (including major political events) in order to develop a model through which one would be able to predict market moves RETROSPECTIVELY. Yes, you heard me right. They were not even at the stage yet of developing a prospective prediction model.
However, the study concluded that “[m]acroeconomic news bearing on fundamental values explains only about one fifth of the movement in stock market prices.” In fact, they even noted that “many of the largest market movements in recent years have occurred on days when there were no major news events.” They also concluded that “[t]here is surprisingly small effect [from] big news [of] political developments . . . and international events.”
In 2008, another study was conducted, in which they reviewed more than 90,000 news items relevant to hundreds of stocks over a two-year period. They concluded that large movements in the stocks were NOT linked to any news items:
“Most such jumps weren’t directly associated with any news at all, and most news items didn’t cause any jumps.”
As for me, I maintain no illusions regarding causation of market moves. To me, it is clear that the directional move is based upon market sentiment at all times, and the substance of the news is not material to the directional bias. Recently, sentiment was set up to take us higher in the metals after the Fed announcement. And, the fact that we went up even though most believed that a rate hike was certainly going to cause the dollar to rally and the metals to drop helps prove my point, yet again, at least to those who are reading with an open mind.
This situation was no different than when I stated back at the end of the first week of November of 2016 that the S&P500 was bottoming, and would rally to 2300 by year end NO MATTER WHO WON THE ELECTION. If you remember, everyone was convinced that if Trump won, the market would tank. And, the fact that it rallied to 2300 even when he won was quite similar to this event we just experienced with the metals rallying in the face of a rate hike.
So, again, the market continually provides us with examples of how sentiment trumps all other supposed market forces. The question is if we are willing to believe our eyes rather than our indoctrination?
See chart highlighting Avi's S&P 500 calls in 2016.
Gold-Eagle provides regular commentary and analysis of gold, precious metals and the economy. Be the first to be informed by signing up for our free email newsletter.