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Gyration Causation

Posted By Barry Ritholtz On July 26, 2005 @ 3:30 pm In Investing,Markets | Comments Disabled

Ever wonder why Markets sometimes shrug off bad news, and in
other instances, seem to over-react? It’s one of the frustrating things about
reading market commentary. All too frequently, attempts are made to explain
day-to-day gyrations by referencing recent events. Any decent trader will tell
you by the time a story hits the headlines, the impact is mostly in the stock’s
price. The exceptions are purely unknown binary events (i.e., FDA approvals) or
events not anticipated (such as September 11th).

As we have seen time and again, similar – even identical -
causal events often produce different market responses. This happens due to
many different reasons, but can help explain why similar headlines often yield
a totally different market reaction.

For example, Markets are peculiarly sensitive to initial
conditions. Consider event X: What came before X this time might have been
different than what came before X last time. The resulting responses seem
inconsistent to X, but is in fact evidence that the markets are responding to
more than this single input.

That’s why trying to predict the market based upon the
behavior of a single variable [1] is so futile. Given the massive size and complexity of capital markets, it is
safe to say that no one single factor can be used to accurately forecast the
market consistently. Indeed, none of the recent “suspects” for market gyrations
- Oil, terror, interest rates, earnings, GDP – operates in a vacuum. Not just
what came before, but what is going on simultaneously with any single event can
cause different outcomes. Because of this, its foolhardy to describe market
doings solely on the basis of Y.

Sometimes a sell off produces nervous holders, and the net
result is more sellers; other times it creates a condition of exhausted
holders. When that happens, we get a
selling vacuum, which sets the stage for a strong move higher.

Then, there’s the issue of collective sentiment [2]. In the first half of the year, the markets were suffering
through a malaise; It wasn’t until the late April lows that a significant shift
in attitude occurred. Institutional buyers found a new want for stocks after
that wash out. The net result was an increased appetite for risk as well.

These various explanations are why the markets sometimes
rally while Oil is moving higher; why they shake off a terror attack, using it
as a launch pad for a move up; Why Fed hikes haven’t had a particular bite yet.

Article printed from The Big Picture: http://www.ritholtz.com/blog

URL to article: http://www.ritholtz.com/blog/2005/07/gyration-causation/

URLs in this post:

[1] single variable: http://bigpicture.typepad.com/comments/2005/05/single_vs_multi.html

[2] collective sentiment: http://bigpicture.typepad.com/comments/psychologysentiment/index.html

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