What Moves Markets?

In Lose the News, we asked:

"Have you ever noticed how the stock market reacts differently to the same reported events? Why
is it that we sometimes sell off "in response to rising oil prices,"
but at other times the "market rallied, despite the rise in the price
of crude"

How come a selloff was caused by a suicide
bombing in Iraq, but a week later, the markets shrugged off an even
larger, deadlier bombing? Is it possible that the markets are
responding to forces other than the latest headlines?"

The WSJ’s E.S. Browning  asked a similar question yesterday — only the specific catalysts he reviewed were Washington D.C. scandals:

For the stock market, a big Washington scandal usually is little more than a tempest in a Teapot Dome. From President Harding’s Teapot Dome scandal — named for a Wyoming rock formation atop a misused government oil reserve — through the Clinton impeachment, stocks have proved remarkably impervious to news that has roiled the political world.

It happened again last week. Thursday’s stock tumble was influenced by reports that White House aide I. Lewis Libby was about to be indicted. But stocks quickly rebounded Friday even before the indictment was announced. Down 115 points on Thursday, the Dow Jones Industrial Average soared 172.82 points on Friday to 10402.77, up 187.55 points, or 1.8%, on the week.

Some of Friday’s advance, certainly, reflected investor relief that the waiting was over and that Karl Rove, president Bush’s political guru, wasn’t indicted. But the investigation of White House leaks continues and Mr. Rove remains in legal jeopardy. When the indictment was announced during the day, the market fell, but just for a few minutes, before resuming its rise. Traders said Friday’s gains appeared to have less to do with politics than with economics. They reflected pleasure that the government’s report on third-quarter economic performance, also out Friday, included low inflation figures and good growth numbers.

And that is the way it usually goes with political scandals. Corporate profits, inflation and interest rates are what drive stock prices. Unless political news affects those things, by making a tax increase or an economic slowdown more likely, its impact on markets tends to be short-lived.

You can do alot worse than just those 3 drivers: Corporate profits, inflation and interest rates. Of course, I think its the interplay of those factors with Psychology that determines when P/E multiples expand — and thats an even bigger driver of market returns.

Here’s the Journal’s look at numerous scandals and their subsequent market impact:

click for larger chart
graphic courtesy of WSJ


Bottom line: Non-economic news events do not drive markets — unless it is capable of causing significant Sentiment  shifts: Watergate, the waste of Viet Nam, the Carter malaise.

Over the past year, we have made note of the "statistical cheerfulness" of government releases. The underlying reason for the juiced data is simply to maintain this Sentiment above that crucial threshhold where psychology spills into the economy and the markets. 

Forget Supply Side Theory or Milton Friedman’s Monetarism: The true economic philospohy of modern governments is "Don’t Worry, Be Happy (and please keep on spending)."


So, What Really Drives the Stock Market?
Politics Certainly Can Play Role, But From Teapot to CIA Leaks, Economy Has Had Lasting Impact
THE WALL STREET JOURNAL, October 31, 2005; Page C1

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  1. D. commented on Nov 1

    I remember your post about the multiple expansion vs. the lack of earnings growth because in the last couple of years I have been doing that same analysis.

    My conclusion is that the multiple expansion is linked to the strong US dollar. Charts show that multiple expansions occured around 1995 just as the dollar took off. The whole world wanted to invest in the US.

    Technology and the New Economy were the new mantra. The world became mesmerized by US creativity and its growth opportunities. The bubble imploded in 2000 but markets are still afraid to bet against the US. They still want to believe in the US machine.

    But with all the imbalances out there, something is bound to happen and I wonder if a lower dollar would bring down the multiples.

  2. anonymous commented on Nov 1

    maybe it is male models-

  3. ann commented on Nov 1

    The fact that this reality has to be mentiond scares me. Here we have what are supposedly among the world’s best analysis and they have a culture which actually believes that there is strong accuracy in the “explanations” for various events. People just grab an excuse because they don’t want to live with ambiguity.

    This is obvious to anyone who seriously analyzes information,. it happens all the time.

    Yet these claims are taken seriously like the idea that the market incorporates all relevant information. Look some expert could announce that we’d be out of oil in ten years and prices would fall and investment experts would announce now is a great time to buy stocks for your retirement and don’t worry that the world economy will stop 20 years before that because our perfect market has already taken that into account.

    Quite simply the best informed people in areas such as politics, economics and all the social studies can only make (highly differing) educated guesses on the results of certain events. Markets can’t measure these based on the snap judgements of busy traders who have 2 minutes for the news. Similarly all sorts of things including momentum and intrinsic value and guesses at future events drive prices.

    This is known.

    Yet they want to tell the chumps that all these fluctuations are responses to front page stories.

  4. alex norman commented on Nov 1

    I am of the camp that believes that different factors are key in driving stock prices over different time frames.

    over the long term, valuation (ie- multiple expansion or compression) is the most important driver of stock prices.

    Over the medium term, interest rates and inflation.

    Over the short to medium term, corporate earnings growth.

    And in the very short to short term, sentiment or market psychology is the most important driver of prices.

    Of course, when extreme, sentiment takes over and can become the most important driver of prices for an extended period of time (Nasdaq 1997-2000, Residential RE 2001-2005(?))

  5. Emmanuel commented on Nov 1

    I’ll second Mr. Ritholtz’s opinion here. Behavioral finance has attempted to explain the various phenomena described in the post. True, they haven’t looked at a huge range of behavioral inconsistencies among investors, but this is a young field.

    Once you accept the idea that “Rational Economic Man” is a convenient but flawed metaphor for an investor, you come to a clearer understanding about the interplay of emotions and market events. I recommend the book “Beyond Greed and Fear” as an OK introduction if you’re interested in Behavioral Finance, though it’s getting a bit dated and there have been quite a bit more studies done since its publication.

  6. Lord commented on Nov 1

    Haven’t you realized the stock market doesn’t respond to events, it causes them. As good a theory as any other.

  7. lord moranosa commented on Nov 8

    my brother, who co-owns and co-operates a small but profitable production company, lost 40k five years ago during a scandal that compelled the brokerage firm putman to declare bankruptcy (…and ressurrected itself, operating as if nothing ever happened to them …).

    the situation taught him one enduring lesson – never ever buy into the hype of ‘the market’.

    in ann’s post, she mentions how the ‘theories’ of ‘the market’ seem slanted towards assuaging the fear of ambiguity that many individuals have: that that existential abyss called ‘the unknown’ acts as a central core that fuels ‘the market’. i tend to agree with ann deeply because all one has to do would be to look at any television ad for any brokerage firm, and the underpinnings are pointing towards that mantra of ‘what-would-happen-if-you-were-not-there-for-your-family’s-financial-security’ ….

    fear goes exert influence from within and from without ‘the market’. the influence and scope of influence that fear has can never be underestimated, and remains always misunderstood underneath the gloss of ‘making-sure-in-your-golden-years-of-retirement-you-have-monies-waiting-for-you-and-your-spouse’.

    ‘experts’ sit around to pontificate; books are authored by ‘experts’ whom sit around to pontificate about the do’s and ‘no-do’s’ about ‘the market’ …. ‘the market’ remains a large parasitic entity designed to obscure and defer and deny, while remaining inflated with ‘potential’ until the weight of this beast can no longer support its own weight, let alone create any type of sound and enduring economic legacy.

    current ‘policies’ taken by the bush regime reveals an eagerness to clean house by creating a caste system of the deep have’s and the deeper haven’t-have-anything-but-debt. ask those ‘survivors’ of category class five katrina survivors without home, and their material possessions. or better yet – do some travelling throughout the united states to realise that the caste system of the liquid and un-liquid remains in pure ongoing and relentless affect….

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