Thursday, 4 July 2013

The share market has gone mad...when bad news is good news

The financial markets and the investment world generally has gone mad.   When bad news is good news in the stock market and I see headlines in the financial news saying that the stock market rallied on weaker than expected financial news or that it was weaker on better than expected news you know that the markets are not working in their proper way and that something out of the ordinary is happening.

Even if you do not follow the financial markets closely you cannot have failed to notice the stock market tanking over the last month.  Indeed most major stock markets have lost the strong gains they have made since the start of the year.  One of the major causes of this was an announcement by Ben Bernanke of the US Federal Reserve that the economy was recovering to such an extent that they would consider starting to roll back QE3.

A recap on QE3

When QE3 was first announced I posted about it, what it was and why the share market reacted so strongly to it.
In brief QE3 was the US Federal Reserve printing money and buying back US Treasuries and mortgage backed securities to provide liquidity in the market
This was to force down interest rates and force lending to start as the yields on these products were depressed to levels so that people would have to invest elsewhere.
QE3 was only ever going to be a short term measure! 
You cannot continue printing money into infinity in order to provide liquidity in the market.  It was only going to be a short term measure to get the economy kick started again and guess what?  It worked.  The US economy started to recover strongly with economic growth rebounding and the share market reflecting this

So why did the market react so negatively towards the announcement that it would be scaled back?

I personally think that much of it has to do with how short term investment managers and profit makers are these days.  In the short term you would expect the share market to pull back as yields recover
in other financial securities and there is a switching back into these securities which previously had artificially depressed yields.

In the short term therefore you would expect the share market to either pull back or grow at a slower pace than would otherwise be expected.  If you were particularly short term in your thinking or if you wanted to make quick profits you would try and get out of the market in advance of it falling (i.e. in advance of QE3 ending) and then get back in when it was lower, making a profit (or avoiding a loss) along the way.

The problem with this however is that it causes the market to tank when it is done by everyone.  When everyone thinks the same thing it makes the market decrease significantly in advance of the actual correction or removal of liquidity happening.

Has the market overshot?

This is the hardest question to answer and it is impossible to know.  Everyone knows that the market would pull back by some amount when QE3 was removed - it was only ever going to be a short term measure - but no one knows by how much.

It is possible that the market has totally over-reacted and that the fundamentals actually imply that share prices should be at higher levels OR it could be that for the market to reach it's natural equilibrium there is further to go.  There is no real way of telling.

I personally do not know however I am using this opportunity to buy into the market at different points.  I am not hitting the market at one go because I do not know if there are further declines to come however I am buying in to index funds as the market continues to fall and dollar cost averaging my way down.

So why is the market reacting well to bad news...and negatively to positive news

This is the perverse thing about the markets currently.  Market participants believe that if there is bad economic news that QE3 may continue which would buoy the share market however more good news suggests that the program is more likely to be cut which would cause the decrease in the share market I have described above.

The whole system has gone nuts and people are trading more in order to gain short term profits rather than on any long term fundamental basis.

You May Also Be Interested In:
What is QE3 and why did the share market react so strongly to it?
What does 'generating alpha' mean?
What is the difference between the Dow Jones and the S&P500?
I am no longer a believer in the Efficient Market Hypothesis

1 comment:

  1. Totally agree with you that share market and also investors are going to be mad when the good news turns into the bad news.i just started investing money here and i am experiencing all the things in share market.All time share market news give us shock.