The Ex Post Facto Market Rationale

Ex Post Facto: from or by subsequent action; subsequently; retrospectively; retroactively. From late Latin, literally, from a thing done afterward

I want to discuss a problem that exists in the narrative form of market commentary, one that I hinted at last night but did not have the time to fully explore in our limited interview. It makes fine fodder for our friendly Friday philosophizing.

The issue at hand is the tendency to explain what just happened int he market after — and not before — it specifically occurs. I call this the Ex Post Facto^* Market Rationale, and this week’s turmoil is a perfect example of it.

Why is this an issue? Because it reflects so many human cognitive foibles all in one place. Indeed,  Ex Post Facto^* Market Rationales combine many of my favorite cognitive themes:

1) Humans love a narrative, much preferring it over hard data. Hence, their attempts to explain what just happened in a normal logical tale despite a lack of evidence.

2) Most of the day-to-day action is random noise, which defies rationale explanation

3) As a whole, most investors have a very poor understanding of what is going on yesterday or today. Comprehension of events usually lags by months or years.

4) The natural tendency to assume most previously known, widely dispersed information is the same as previously unknown information (A/K/A breaking news).

5) The very human tendency to try to impose order on chaos, to see patterns where none exist, to be confused into thinking randomness exists for some form of rational reason.

Is the explanation as to why markets fell — a drop of 2% or worse is something that has happened literally 1000s of times previously — accurate? Was the 675th worst one day (2.34%) Dow selloff in history all about the Fed’s taper of their bond purchases?

My honest answer is I don’t know — but I highly doubt it. Why? Because there was very little new in what we learned from either the FOMC or Bernanke yesterday.

-Will the Fed eventually end QE? Yes

-Does the Fed think the economy is slowly healing? Yes

-Are their economic forecasts even remotely accurate? No, they have ALWAYS been too bullish.

The one arguably new piece of data was the Fed’s forecast that their target levels for ending QE of 2% inflation and 6.5% unemployment might occur in late 2014 instead of early 2015. But even that is not all that new, because the prior 2015 forecast was made when Unemployment was higher and stickier. It was not a big leap to deduce that based on changes in employment data, the Fed’s Unemployment target was going to be hit sooner rather than later. So even that piece of news was not very new.

Perhaps a better explanation was what we discussed 10 days ago: Up 16% in the first five and half months of the year is simply to rapid an ascent; we are now looking at whatever rationales afte the fact — ex post facto — to justifiy returning to a more normalized market real rate of return.

You can always find an explanation for what just happened that gives you a warm fuzzy and makes you emotionally comfortable. Just be aware that it is more likely to be false than true . . .
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^* What does Ex Post Facto mean? It is actually a legal term that states governments cannot retroactively change the legal consequences of any action after its occurred.

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With this post, we had the category “Cognitive Foibles.”