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Does News Move Markets….Sort Of…Maybe…Well No Actually

I was chatting the other day with someone who was having trouble with their trading system. Their approach was based on trading news events. Such a plan is predicated on the notion that news events move markets in certain ways and whilst this movement might not be wholly predictable it will at least generate some form of activity. Such a trading system has a single giant assumption – that news and news related events move price. If this maxim does not hold up then the system is a bust.

It has been sometime since I looked at this question and I had a vague recollection of research done in the 1980’s that looked at this question and found that news as a source of trading ideas was a bust. So armed with the dimmest of memories I went looking through my archive and found what I was looking for. David Cutler, James Poterba and Lawrence Summers produced a working paper titled What Moves Stock Prices for the Department of Economics at MIT in 1988. This paper looked at the 50 largest single day moves in the US market since World War Two – I have included the events from the original monograph below.

Event 3

If you take a cursory look at the events above you could argue that news events do move markets. However, there is a glitch in that some movements defy explanation – there is simply no event that can be seen as a casual trigger for a market move. Cutler et al stated that news events could really only be useful as an agent for movement in about half of all cases of the variance in stock price movement and in my world half is a fluke.

The interesting side issue with the work of Cutler et al is that it puts another hole in the Efficient Market Hypothesis because stock price movements according to the EMH reflect the assessment of investors to new information. If markets move without the the addition of new information to the system then something else is happening that is not explained by the EMH. And it seems in the case of broad brush analysis as performed by Cutler that prices move without any significant input.

This initial work has been expanded upon by Ray Fair at Yale University who looked at outsized movements in the S&P500 futures contract. This new work had much greater granularity to it in that it looked at five minute data, something that would have been difficult in the original work by Cutler and crew simply because the available technology would not have allowed it. Fair compared what he defined as big movements with news items emanating from the Dow Jones News Service, Associated Press and New York Times. The upshot of this investigation seemed to be that the majority of large events have no news based driver. They were only able to attribute a news item to 69 of the 1159 big moves that were examined. Recent  flash crashes seem to support this notion of significant market moves  occurring without a notional driver.

So we come back to the original assumption that news events drive markets and that these moves offer opportunities that can be traded. It would seem on the evidence available that this notion is false.

‘Earnings bonanza’ to fuel strong growth for Australian shares in 2017

I do enjoy it when people email me to ask me about something they have read in the media. My enjoyment comes from the simple fact that I dont read business publications. I find them irrelevant, stupid, depressing and generally lacking in original thought. However, in the spirit of being polite I did take a look at this article from the Fairfax trash pile. The basic contention is that corporate earnings will go through the roof and that this will drive share prices through the roof. Implicit within any such article are two very basic assumptions and these assumptions are the foundations upon which this argument sits. At the heart of the piece is the assumption that analysts are capable of making accurate predictions regarding the direction of earnings. Secondly, it is assumed  that perceptions of future earnings drive share prices.

With regard to the former, the forecasting track record of advisors is poor with a tendency to consistently overestimate earnings as shown by the image below. Analysts are persistently in the grip of optimism bias when it comes to forecasting and this adversely impacts their ability to make any form of accurate forward judgement. This lack of ability is also clouded by the hubris involved in thinking that you can make an accurate prediction about anything.


Source – Dr Ed Yardeni

The psychology behind this incompetence is reasonably easy to understand once you understand the nature of the finance industry. This is the dont bite the hand that feeds you syndrome. Within the finance industry very little money is now made by the sell or advisory side of the industry. The big money has always been in corporate advising, that is restructurings, capital raising and the like. It is here that the fees total in the tens of millions of dollars. As such you dont want to offend companies that you might do very lucrative work for by telling everyone that their business is crap and that the company is run by people who would struggle to run a Mr Whippy van. It is much better to tell everyone that that the sun shines out of their proverbial and that everyone will get a free unicorn in the morning.

The second assumption is whether or not earnings drive share prices and this to my way of thinking is a more interesting problem since it moves into the realm of investor perception. To get a sense of this I looked at the year on year changes in earnings for the S&P 500 and compared that to the yearly return for the S&P 500 and plotted these initially in the form of a simple bar chart to get a sense of any form of relationship.

earnings bar

However bar charts dont really give a true sense of relationships or correlations so I  plotted the data as a smoothed scattergram.


So the question is what do the squiggly lines tell me. They tell me that sometimes earnings growth and share prices move together and sometimes they dont and if I do a bit of dodgy stats-fu on my trusty old Casio I find that that changes in earnings and share price growth have a very weak correlation of 0.37. The reverse intepretation is that most of the time they dont share a relationship. But there are some caveats in generating correlations. The correlation I generated is what is known as a Pearsons correlation, this looks at the linear interdependence of variables and it can be affected by outliers such as we see in the rebound from the GFC. I also wonder about true independence between variables over time – my concern comes from the fact that markets seem to have memory and this in turn loops back to the impact of data on investor perceptions over time.

The wonderful thing about being a trader is that our perceptions and our benchmarks are very simple and they revolve around the idea of whether something can help us to make money. In this instance neither the faulty predictions of analysts nor their profoundly weak impact upon price movements convinces me that that either idea lives up to their hype.







So January Goes

Since it is the season for both looking backwards in an attempt to explain the past and make predictions as to the future I thought I would add my own meaningless contribution. There is an old adage that January predicts the course of the coming year and a variation of the chart below has been doing the rounds so I thought I would generate my own.

S&P500 Gain

My rough working out indicates the January “predicted” the outcome of the year about 66% of the time with some unfortunate and notable exceptions – there are always exceptions. I will revisit this at the beginning of February to firm up the prediction (wild guess)

Have A Guess….Any Guess

I should add that once a year Marc Faber who is cited often on this chart pops up and says the end of the world is coming. No doubt one year it will and he will bounce around in triumph and the dimwitted double digit IQ plonks in the media will laud him as a genius.Capture




















Source @JonBoorman


Trump, Brexit, and predictions in an age of uncertainty

If 2008 was a sharp reminder that banking matters, then 2016 has reminded us that politics matters too — and, in both cases, the reminder has not been especially welcome. How should economists respond?

Until recently, both banking and politics tended to be something of a niche interest in the economics profession. This isn’t quite as insane as it might seem: if you want to analyse a complex world, you’re going to have to make some simplifying assumptions. For a generation or more, in rich countries, both banks and politicians have seemed complicated and not terribly important, so many economists have ignored them.

Development economists have paid closer attention to politics and have been rewarded for their efforts. Daron Acemoglu won the John Bates Clark Medal in 2005, and the late Elinor Ostrom, a political scientist, won the Nobel Memorial Prize in Economics in 2009. The reason for their interest is obvious: malfunctioning political institutions are a major reason that poor countries are poor.

In the wake of the Brexit vote, Trumpism, the rise of Marine Le Pen and the coming constitutional referendum in Italy, it no longer seems tenable to ignore the economic effects of politics in the western world. But how best to take them into account?

Some economists argue that financial markets are actually an excellent window into politics. For example, Justin Wolfers, an economist at the University of Michigan, tracked US stock futures prices during the first presidential debate. Stocks rose as Hillary Clinton got the better of Donald Trump, and betting markets upgraded the prospect of a Clinton victory. Implicitly, the market was saying that a Trump presidency would knock more than 10 per cent off the profitability of corporate America — and was relieved to see that risk fading.

More here – Tim Harford

On Change

Now that the Bogan 1000 has been run at Bathurst for another year I note that there was much weeping and wailing at the imminent demise of Ford which is soon to be followed by the end of locally produced Holden’s. This gnashing of teeth was echoed by the car magazines I subscribe to which devoted their entire contents to reminiscing about the good old days when Australians wore stubbies and thongs and drove local cars. Before, I belt the local car industry which is a little bit like kicking someone when they are down let me state my credentials. I am a car nut – I tend to turn over cars like other people change shirts. I have owned cars from all around the world of all sorts of different shapes and sizes. From a Valiant Station wagon which was the only car I have ever owned that you could actually stand in the engine bay to work on to temperamental European pieces of high tech craftsmanship. I have even been silly enough to own an English car but only once….

I have been a keen observer of the car industry since before I could drive and in a bold pronouncement I will state that the demise of the local car industry was completely and totally foreseeable. It was obvious from the moment I sat in one of the first Golf GTi’s and an old girlfriend turned up in a Mazda 3. The collapse of the car industry is a keen example of a complete and utter failure to adapt to a changing world – evolution is not only a biological function, it is also an economic one. Change or disappear, the outcome is wonderfully binary in nature so it leaves no room for doubt. Much has been written about the ending of production of locally made cars and most if it is wrong since it fails to address the simple notion of adaption as a function of survival. Blame is sheeted home to all sorts of places and for some reason various governments get the blame for not propping up an industry that turned out a poor quality product that was always a generation behind what was being produced in Europe. When foreign manufacturers were installing airbags as standard features local manufacturers insisted they were luxury items.

It is intriguing to me that the peanuts who ran the local car industry would look out of their office windows and over the decades and see a change in the ecology of their workers car park. The days when all workers drove the local product to work began to change in the 1980’s and for some reason they were completely blind to this occurrence. Delusion is a powerful force in shaping how we see the world.

At the heart of this is a fundamental need for honesty in assessing our own performance of seeing what we do well and more importantly what we do poorly. You would imagine in a profession such as trading that there is little room for delusional behaviour; surely the cold hard nature of our profession would keep us honest. The correctness of our decisions is obvious, we either make money or we don’t. However, this is underestimating our power to craft a reality that seeks to protect our ego at all costs. Losing trades suddenly become winners in our mind and we plough on regardless of the financial consequences of our actions. The protection of our egos is paramount and is central to the way we behave. We will seek to preserve its integrity at every turn.

The preservation of ego is a function of an emotional investment in the outcome of the decision. Whenever we undertake a trade we are actually setting in place two trades. The first is a financial one, the second an emotional one as we stake our identity on the outcome of the trade. This second investment often precludes change if we are fragile in our self image. If all you have in terms of an emotional reservoir is the outcome of either a single or a series of trades then you will not have the ability to adapt to changing circumstances.

To me the crux of trading is represented by a series of paradoxes which in some way goes to explaining why it is so difficult. You need to be smart enough to write a trading plan but stupid enough to follow it. At the same time you are robotically following your plan ignoring all outside influence and your own emotions you also have to be attuned to whether it is working and whether you need to change. But you cannot change simply because you were bored, there has to be an actual need for change. Yet this observation can only come about being carefully tuned to the emotions you are at times seeking to ignore. It is no small wonder that we find this a challenging endeavour.

Despite its challenges trading does represent a chance for the keen self observer to mould their behaviour and their trading to whatever circumstances arise. This fluidity is not something that is offered by most other professions. Trading is infinitely malleable but it can only change in response to a reasoned observation of a change in your environment or performance. Change for the sake of change which is really just another way of expressing a low threshold for boredom and sticking to a task sounds the death knell of the trader. So we have another paradox, we need to not change on a whim but be every ready to change.



I See Idiots Everywhere….

On the back of the news that that BBY head Glenn Rosewell hired a psychic who strangely enough was not able to predict the demise of the firms at a time when it was obvious that full service broking is stuffed as an industry comes the news that apparently NASA has ruined peoples lives by changing their star sign.

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