The News Theory of Market Behavior
By: Brad Thomason, CPA
When the market drops (or goes up, for that matter) everyone wants to know what caused it. Which is a reasonable desire, as far as it goes. To cater to this desire, there are lots of news outlets that are devoted strictly to market news; and even the ones that cover general topics, like CNN or NPR, almost always have market updates frequently throughout the business day. Every time the market moves, someone is there to tell you why.
Now, there’s no question that news events can move markets. What’s less clear is whether that’s a two-way street: do all market moves have a corresponding news story? Or is it possible that things outside of the news cycle cause market movements, too?
This is a subtle question, but an important one; because it gets at the deeper question of causality. If news moves the market, so be it. But if the market moves for another reason, and we spend our time looking for the news story (or assigning a news story without a strong case for doing so), is that a very productive thing to do?
Over the weekend I read several explanations for why markets ended last week lower. Most of them came down to concerns over what was happening in China and Greece. Specifically, the Chinese economy is slowing, the country has likely built a lot of extra infrastructure it doesn’t really need, and its stock market is overvalued. Greece is apparently having some troubles of its own, both on the financial leadership front.
Well, no kidding. People have been voicing those concerns for months, if not years. So how is that exactly news? What is it about those situations that changed so dramatically over the course of a couple of days that it lead to what happened in the markets? Yes, there were a couple of new plot points to occur in each storyline. But didn’t we already sort of know that it was coming; or at least something like it was coming? Is the news theory really sufficient to explain what we are seeing? I tend to doubt it.
The problem is that we’re trying to make simple comments about very complex things. Even if it is valid on a given day to say that US stocks fell because Chinese stocks fell, it doesn’t answer the question of why Chinese stocks fell that day. Not big picture, but that particular day. People have been concerned about those valuations for a long time. Why the down turn on that day? That’s a tougher question. Same thing with Greece. It’s not like we all woke up last Friday and learned that things were a mess.
Now again, news does sometimes move markets. But the point here is that sometimes the news story itself is not a sufficient explanation. This is especially true on days when no point-specific events occur and there are big market moves anyway. The news outlets still go hunting for the why, and if you’ll notice they almost always manage to come up with one.
The danger to investors is getting lulled into thinking that news drives all, and that the markets are so simplistic that a single factor could account for what we see in the first place.
Beyond that, there’s also the human impact of selection. News outlets can’t tell every story, so they have to choose. Last week they seized on China and Greece. Less publicized was the fact that the price of oil had a significant price dip during its trading activity. The price of oil is a stand-in for the health of the global economy. Falling prices may be a bigger news story than any of the others, to the extent it represents a change in the views of those who produce and use oil. Given that the stock market is generally considered a leading indicator – something that moves ahead of actual economic change – the decrease in oil prices could end up being something truly substantive which the stock market historically reacts to by falling. So what may have been the real story (to the extent that it was just one story that lead to the drop) wasn’t even the one that got top billing.
People in the news business have an interest in highlighting the link that sometimes exists between the news and market moves. But wise investors take that with a grain of salt, and appreciate the fact that complex things often can’t be talked about in 15 second sound bites. There’s a lot more going on than just a couple of news stories. And successful navigation of the markets often hinges on being able to discern just what those moving parts are.