Sunday, November 1, 2009

Opposite Market Reaction to Similar News Implies Rally Exhausted


Analyst Angst: Same Event, Opposite Reaction, Proves Sentiment Rules

Or, A Tale of Two Rate Increases: How a Moody World Market Reacted in Opposite Ways to the Same News

What a difference a few weeks can make. Here's a salutary lesson about why markets can be so hard to predict based on fundamentals alone, and why analysts can be right about events and wrong about how the market reacts to them.

While equities tend to drive currency markets, there are times when currency markets can move both equities and commodities. Moreover, the same kind of news can cause the opposite reaction, depending on the market's mood at the time.

If Risk Appetite, Then Rising Rates Imply Recovery

When Australia announced that it was raising interest rates, markets were already in rally mode and moved higher still on the news, citing this first rate increase among the major economies as further proof of ongoing global recovery.

Higher rates meant supported the recovery thesis.

If Risk Aversion, Then Rising Rates Imply Stagnation

Yet just this past week, Norway became the first European country to raise rates. The markets should have been even more thrilled. After all, Australia is part of the higher growth Asian block, and has the fastest growing economies as primary trading partners. Growth comes easier down under. Norway, however, has to manage in a tougher, slower growth neighborhood, Europe. That the Norges Bank would have enough confidence to raise rates could have been seen as even more bullish.

However, markets were already in retreat mode due to justifiable concerns that stocks and other risk assets were already overpriced. Thus when the news about Norway's rate increase came out, the media cited it as one of the reasons for continuing market pullback. Why? Because perhaps the rate increase was premature and would cut off the nascent recovery!

Yes, Norway's rate increase was anticipated, but so was Australia's.

Implications and the Real Lesson—Trend Exhaustion?

The likely resolution of the apparent contradiction is that when Norway's rate hike came, the current rally was simply tired. In other words, those ready to buy had already bought, those who hadn't are waiting for a pullback to buy lower or go short risk assets

The lesson: Before predicting an event's effect on the market, look at a daily chart of the S&P 500. That's my favorite single picture of market sentiment. Feel free to select others that correlate to the asset in question. If the trend is down, even good news could be taken badly, and vice versa. Of course, if a move

Disclosure: No positions in the above instruments

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