This is what happens when one tries to make sense of non-sense or try to explain a daily move in stocks, even if it is a big move like it was on Friday in the US. It is a move of +2% or more in Dow-Jones index and S&P 500 stocks. Made no sense. US dollar rallied because of a strong jobs data. That should have been bad news for US corporate earnings. Yet, stocks rallied. The rally in US dollar is a big negative for gold. Yet, gold rallied. A drop in the price of oil was bad news for energy stocks. Yet, the stock index rallied. Strong employment data and the strong dollar are not good news normally for US Treasury paper. Yet, US Treasury prices rose. It made no sense. But, the Bloomberg story tries to paint a ‘rational’ picture of the action in US financial markets yesterday and comes a cropper. The explanations are farcical and cause mirth.
Wall Street Journal has a good explanation for the bizarre price action that followed the European Central Bank decision on Thursday. ECB did push the rates deeper into negative territory. It said redemptions and interest amounts from bonds owned by ECB would be reinvested. It extended the duration of the programme by six months up to March 2017. But, the market had expected more ludicrous stimulus measures such as boosting the amount of assets purchased every month! Hence, it was disappointed.
The Euro strengthened very sharply rising from around 1.05 to 1.09. This is a kind of move that would have accompanied an aggressive and unexpected tightening of monetary policy – sharply higher interest rates. European stocks tanked. So, did US stocks because Ms. Janet Yellen had given enough hints the previous day that she was determined to boost the Federal funds rate to 0.25% later this month.
All these outsized moves are explicable only because of the situation of crowded trades – herd mentality among traders and investors. That is what explains the bizarre action in the opposite direction on Friday. Fundamental explanations are silly. They make no sense.
Financial markets had been corrupted by central bank purchases of bonds and liquidity injections. They compound the investor tendency to ignore bad news or worse, celebrate bad news for the economy as good news for stocks. Financial markets have no relation to economic fundamentals. They are not discounted present values of future fundamentals. They are devoid of any meaning.
Bill Gross writes in his December 2015 investment newsletter:
I would gradually de-risk portfolios as we move into 2016. Less credit risk, reduced equity exposure, placing more emphasis on the return of your money than a double digit return on your money. Even Martingale casinos eventually fail. They may not run out of chips but like Atlantic City, the gamblers eventually go home, and their doors close.
Amen to that.