Why markets rose despite bleak economic news
(MoneyWatch) COMMENTARY The economic news was nail-bitingly scary last Thursday and Friday. On Thursday, initial jobless claims came in 11,000 higher than expected and the May consumer price index declined by 0.3 percent, showing more deflation than economists expected. On Friday, the May industrial production showed a 0.1% decline vs. the 0.1 percent growth the market was expecting.
In addition to the chilly economic news, the uncertainty of the Greek election, and the possible collapse of the euro causing a liquidity crisis similar to 2008, loomed on the horizon. On Friday, there was less certainty the pro-bailout party would actually win, as they did. Though markets hate uncertainty, markets really hate the combination of uncertainty with bad economic news. Put them both together and you have the formula for a market plunge.
As it happens, however, that's not what the market chose to do. Flying in the face of the market plunge formula, and the predictions of my crystal ball - which were that U.S. stocks would have given up between two and five percent of their value - U.S. stocks actually gained 2.1 percent, as measured by the Wilshire 5000 comprised of nearly all U.S. based stocks. International stocks clocked a similar return. Which begs the question: Why? How about one of these headlines I made up?
- Markets oversold, buyers return
- Investors turn bullish on Greek election
- Cheaper oil seen as new stimulus
- Markets shrug off bad news as optimism returns
- Markets up - reasons unknown
Being more comforting, the first four headlines are likely to reel in more readers. But the truth is I actually don't know why markets do what they do in any given day or week. Word has it that as a financial planner and journalist, I'm not supposed to admit I don't know.
There is no harm in pretending we know why financial markets performed as they did last week, but the slope gets pretty slippery when we attempt to extrapolate the reasons into the future. Indulging in the belief that it is possible to know how financial markets will trade this week will only lead down the very slippery slope of market timing which, research shows, will lead to much lower returns.
My advice is to accept that we don't know why markets rallied in the face of bleak and disappointing economic news and Greek political uncertainty. We also can't be sure the Greek election results will lead to strong returns this week. This paves the way for the more profitable extrapolation of knowing we don't know what next week holds for stocks and avoiding market timing.
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