Trading News - Bad is Good, Good is Bad?
For those who are new to the financial markets, you may find market reactions to news kind of baffling. What seems to be good news, at least on the surface, sometimes sinks the market. And what looks bad made the market rally strongly instead. Then just when you thought the market decided on a direction, it turns after a few minutes, hours, or a day or two later. That is why most people end up losing money trying to play around with news and events. The uncertainty here is twofold. First, what is going to be the outcome of the news or the event? Second, how is the market going to react?
US GDP contracts 1.4% - Is This Good or Bad?
What happened recently on 28 April 2022 is one such instance. A key economic gauge, US GDP, fell 1.4% in the first quarter of 2022. While slower growth was anticipated, that was still way off economists' consensus forecast of +1.1%. The stock market slipped on the news which was released an hour before the market opens.
Sounds bad? But an hour or so after the market opens, the S&P 500 turned and rallied strongly to end the day up 2.5%. The market seemed to like or simply shrug off the weak GDP. At that point, you might think that the market decided on its direction. For that day, yes. But it crashed by 3.6% on the very next day. So is this GDP number good or bad? If this is your maiden encounter with such occurrences, you must be thinking either you are crazy or the rest of the people in the market are.
Well, actually stuffs such as this occurs more often than you think. Since 2008, there are many cases where good economic data trigger a selloff, and bad ones prompted rallies. Or the market just simply whips up and down with no clear direction. A notable one happened in February 2018 when the stock market crashed after the US issued an exceptionally strong labor report. That day sparked volatile moves that led to a black swan event known as "Volmageddon". And it led to the demise of the extremely popular XIV ETF.
But what is so terrible about a strong labor report? Doesn't that mean the economy is in good shape? If that is your interpretation, it is not wrong, except that it is just one out of the many. Here is another. The strong number looks great except that the market saw a bigger threat. And that is it may prompt the US Fed to withdraw liquidity from the market. An ultra-loose monetary policy is the core essence that has been sustaining the rallies and strengthening the buy-the-dip mentality in the years that went by.
How are you going to decide?
There are always different sides to a story or a number. Market participants may hold different views about the same piece of information. And they may structure different trades according to the strategies they pursue. Some will buy, some will sell, and some will do nothing. Technically, none is wrong. But market outcome at any point in time is the collective decision of all these people, so for sure, not everyone will be a winner. It's a zero-sum game.
Now, knowing more about the different perspectives may help in understanding market behaviors. But note that does not mean you will be able to predict how the market reacts. The first and most natural interpretation is always based on what we see. But a deeper analysis often reveals other possible takes. Let's use a few hypothetical examples.
Case 1 - GDP falls far short of expectations
The straightforward interpretation is this. GDP falls short of expectations, so that is bad.
But what if you know this? GDP went down due to a surge in imports and a drop in export believed to be temporary. As a result, more dollars flowed out than in. As far as domestic consumer and business demands are concerned, they are still strong. And a bad GDP number may also slow the US Fed's aggressive rate hike cycle. With this, now the bad GDP has a positive spin to it.
Now, what about this? But on the other hand, if the fall in GDP is temporary and domestic demand is strong, that means the economy is capable of taking on higher interest rates. That also implies inflation might stick a while longer. If that is the case, then US Fed has more room to maneuver and less reason to slow down the interest rate hikes. You can see how just a slight twist in the perspective and we are now looking at a negative scenario.
Case 2 - Inflation is climbing
A persistent level of high inflation is bad because they erode your future earnings. It is bad for stocks. It is bad for most bonds. This is a simple interpretation.
Now, how about adding in this piece of information? The higher inflation we see is believed to be temporary. This is the result of demand surging faster than supply as the economy opens up following the Covid-19 pandemic. There is a bottleneck in supply due to labor shortage and uneven recovery across the globe. And on top of that, there is a war between Ukraine and Russia brewing that is putting upward pressure on oil and food prices. All these are expected to be transitory. Some interpret this as good and may see dips as buying opportunities.
Now, how about this? The real driver of the runaway prices we see today is the result of a decade-long relentless money printing leading to an unprecedented amount of money circulating in the system. The supply chain issues and war are just the sparks to ignite the fuse set in place. Inflation will be more persistent than most thought and it will force Fed to rapidly increase interest rates and withdraw liquidity to bring it under control. In the meantime, markets and the economy will come under pressure from the dual forces of inflation and rising interest rates. And this will increase the chance of moving into a recession. So again, with a slight change, the future becomes darker.
Case 3 - The unemployment rate ticked up
The unemployment rate ticked up. Again, the immediate sensing is bad.
Now, what if the labor participation rate also climbed showing more people are trying to return to the workforce in anticipation of better prospects. And this runs on the back of a growing economy. So even though the unemployment rate went up, the number of people employed actually rose. This suggests a strong labor market instead of a weak one. With this information, then the uptick in unemployment does not seem to matter much now.
The market doesn't move based on what you think
At the end of the day, the reality is your views matter only to you, but not to the market. The market moves based on the collective expectations of all its participants, not based on a select group of economists and certainly not yours. There is a wide range of different market players out there - high-frequency algorithmic traders, short-term technical traders, long-term fundamental investors, long/short funds, macro traders, systematic trend following traders, statistical arbitrageurs, risk, and events arbitrageurs, volatility traders, market makers, hedgers, etc. The degree to which news is useful for them, how they interpret it, and what they do with it can be very different from each other. So it is not surprising to see the market reacting in one way and then the opposite moments later.
If you don't think you have a justifiable edge in predicting market news and reactions, then my advice is don't try to trade it. Save yourself the headaches and gut-wrenching moments watching the market swing from one way to another while cracking your head trying to figure out why it happens. A better approach is to find or learn strategies with a solid fundamental basis and backed by statistical evidence. News and events are part and parcel of the investing and all that are eventually digested and reflected in how the market moves. So even though your strategies may not be directly using the news for quick decision making, they are in a way incorporated.