As I write my weekly articles about how one should ignore exogenous factors such as news or geo-political events when analyzing the markets, I always get a number of people who will argue with me. They see a single news event coincide with a directional move in the market and are absolutely convinced that the particular news event was the “obvious” cause of that market move. They then extrapolate this experience and believe that news and geo-politics are always what drives the markets.
Yet, I remain steadfast in my belief that maintaining such expectations is intellectually dishonest, as it requires you to ignore the many times that markets do not act in the manner most would believe based upon the news or geo-political events.
When the market was whipsawing around in August, and we were catching most of the turns, many of these commenters would proclaim:
“in this instance there is no doubt the driver here is Korea”
These people, who believe the market is driven by exogenous factors, have a real problem today.
If you were paying attention over the last two weeks since the market broke back over 2460SPX, we have had two of the worst weather events in recent times, which have caused damage estimating over $200 billion dollars. To put the true extent of this damage into perspective, this is reportedly about half of the combined costs of all hurricanes over the past 50 years, including Katrina ($133 billion), Sandy ($75 billion) and Andrew ($46 billion).
Moreover, during the past two weeks, we have faced further terrorist attacks along with further provocation by North Korea. Yes, the same North Korea that is “no doubt the driver” of the market.
To be more specific, not only did the hours between the Thursday evening market close and Friday morning market open see another North Korean rocket fire over Japan, we also witnessed yet another terrorist attack in London.
For those counting, that is two major negative geo-political events occurring while the market was closed before its Friday morning open. And, anyone that was so certain that “there is no doubt the driver here is Korea” was likely looking for a major red opening on Friday morning, especially when you couple it with the terrorist attack occurring before the open too.
Yet, what did the market do after it opened on Friday morning? You got it! We rallied to hit new all-time highs, and finally eclipsed the 2500SPX mark.
Again, those that believe in exogenous causation for market moves must be stumped. How can this be possible? Surely, the market must be manipulated, right? I mean, this really can’t happen in real life!?
So, allow me to remind you about some studies I like to post every now and then:
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 . . . explains only about one fifth of the movements 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.” They also suggest that:
“The relatively small market responses to such news, along with evidence that large market moves often occur on days without any identifiable major news releases casts doubt on the view that stock price movements are fully explicable by news. . . “
In August 1998, the Atlanta Journal-Constitution published an article by Tom Walker, who conducted his own study of 42 years’ worth of “surprise” news events and the stock market’s corresponding reactions. His conclusion, which will be surprising to most, was that it was exceptionally difficult to identify a connection between market trading and dramatic surprise news. Based upon Walker's study and conclusions, even if you had the news beforehand, you would still not be able to determine the direction of the market only based upon such news.
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.”
But, I can assure you that the great majority will simply shrug this off for whatever reason they want to believe. They will don their blinders, and simply ignore the actions over the last few weeks, since it does not fit their overall perspective about markets. In other words, they will continue to fool themselves. After all, Ben Franklin put it quite well when he noted:
“So convenient a thing is it is to be a reasonable creature, since it enables one to find or to make a reason for everything one has a mind to do.”
If these past few weeks were not enough to convince you that exogenous factors to not drive the market, about a month ago, I provided you with a list of all the “reasons” most market participants have been expecting the stock market to crash:
Brexit – NOPE
Frexit – NOPE
Grexit - NOPE
Italian referendum - NOPE
Rise in interest rates - NOPE
Cessation of QE - NOPE
Terrorist attacks - NOPE
Crimea – NOPE
Trump – NOPE
Market not trading on fundamentals – NOPE
Low volatility – NOPE
Record high margin debt – NOPE
Hindenburg omens - NOPE
Syrian missile attack - NOPE
North Korea – NOPE
Yet, the market has clearly had other ideas. As you can see, none of these reasons have mattered, as the market has simply melted up towards our longer-term target of 2500SPX, which we pointed towards several years ago, despite much disbelief.
So, either you learn the lessons clearly taught by Mr. Market over the last several years, or, continue donning those blinders while muttering to yourself “it just can’t be.”