Ex Post Facto: from or by subsequent action; subsequently; retrospectively; retroactively. From late Latin, literally, from a thing done afterward



I want to discuss a problem that exists in the narrative form of market commentary, one that I hinted at last night but did not have the time to fully explore in our limited interview. It makes fine fodder for our friendly Friday philosophizing.

The issue at hand is the tendency to explain what just happened int he market after — and not before — it specifically occurs. I call this the Ex Post Facto* Market Rationale, and this week’s turmoil is a perfect example of it.

Why is this an issue? Because it reflects so many human cognitive foibles all in one place. Indeed,  Ex Post Facto* Market Rationales combine many of my favorite cognitive themes:

1) Humans love a narrative, much preferring it over hard data. Hence, their attempts to explain what just happened in a normal logical tale despite a lack of evidence.

2) Most of the day-to-day action is random noise, which defies rationale explanation

3) As a whole, most investors have a very poor understanding of what is going on yesterday or today. Comprehension of events usually lags by months or years.

4) The natural tendency to assume most previously known, widely dispersed information is the same as previously unknown information (A/K/A breaking news).

5) The very human tendency to try to impose order on chaos, to see patterns where none exist, to be confused into thinking randomness exists for some form of rational reason.

Is the explanation as to why markets fell — a drop of 2% or worse is something that has happened literally 1000s of times previously — accurate? Was the 675th worst one day (2.34%) Dow selloff in history all about the Fed’s taper of their bond purchases?

My honest answer is I don’t know — but I highly doubt it. Why? Because there was very little new in what we learned from either the FOMC or Bernanke yesterday.

-Will the Fed eventually end QE? Yes

-Does the Fed think the economy is slowly healing? Yes

-Are their economic forecasts even remotely accurate? No, they have ALWAYS been too bullish.

The one arguably new piece of data was the Fed’s forecast that their target levels for ending QE of 2% inflation and 6.5% unemployment might occur in late 2014 instead of early 2015. But even that is not all that new, because the prior 2015 forecast was made when Unemployment was higher and stickier. It was not a big leap to deduce that based on changes in employment data, the Fed’s Unemployment target was going to be hit sooner rather than later. So even that piece of news was not very new.

Perhaps a better explanation was what we discussed 10 days ago: Up 16% in the first five and half months of the year is simply to rapid an ascent; we are now looking at whatever rationales afte the fact — ex post facto — to justifiy returning to a more normalized market real rate of return.

You can always find an explanation for what just happened that gives you a warm fuzzy and makes you emotionally comfortable. Just be aware that it is more likely to be false than true . . .

* What does Ex Post Facto mean? It is actually a legal term that states governments cannot retroactively change the legal consequences of any action after its occurred.


With this post, we had the category “Cognitive Foibles.”

Category: Cognitive Foibles, Markets, Philosophy

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

27 Responses to “The Ex Post Facto Market Rationale”

  1. jnkowens says:

    It’s a really good, and really subtle point. My guess is most people will disagree. By all appearances, the Fed spoke, the market reacted, and therefore you have a cause and effect relationship.
    But here’s the subtle part: No one that I read explicitly said “If the Fed says A, the market will do B” and get it right. We don’t know WHY the market fell. Did buyers decide to take a wait and see attitude and create a vacuum, while sellers chased bids lower and lower? And does this mean anything going forward, or is it just – as you say – noise?
    Who is the hero that is willing to make a bold prediction about where we go from here?
    The only bold prediction I’ve seen so far is Gundlach’s counterintuitive call on treasuries – and that came prior to Wednesday.

  2. lalaland says:

    The market seems to behave more and more like a school of fish reacting to a predator – tight configurations, all evasive action coordinated by watching the fish next to you. Once the tripwires are activated, it’s just a question of how fast and far does the spiral go before the programs are self-instructed to buy?

  3. cswake says:

    Barry, on your statement “Will the Fed eventually end QE? Yes” – in the light of the fact that they have “ended” and “restarted” multiple QEs to this point and we are four years into the recovery – are you implying that they will not restart it or simply there will be another pause? (permanently vs temporarily)

  4. b_thunder says:

    ” -Will the Fed eventually end QE? Yes”

    I Disagree. Why? The only example of any significance is Japan, and they’re still doing “that QE thing” almost 25 years after the bust. But we’re NOT Japan. Our international competitive position is a lot weaker than that of Japan in the 1990s. Also I doubt that other than QE/monetization there are means of financing the deficit that were available to Japan.

    ” -Does the Fed think the economy is slowly healing? Yes”

    I don’t know what the Fed sees, but unless they stomp rates back down to the all-time lows several sectors of the economy will be in a double or triple “dips” by the time the “taper” is tentatively scheduled for.

    ” -Are their economic forecasts even remotely accurate? No, they have ALWAYS been too bullish.”

    Amen. Always too optimistic. Realistically the economy sucks and the Fed will not voluntarily(*) stop QE for at least another 5-10 years. Maybe 20. If they were to stop now, the fallout will be greater than 2008 crisis would have been had it been allowed to “burn itself out” without the “stimulus” and Fed’s intervention.

    (*) IMHO the only way they stop QE is if suicidal Congress takes that power away from the Fed.

    • Greg0658 says:

      can we live in a QE world forever .. Yes** with a couple of sticklers
      a> “money for nothing chicks for free” – life of a banker (and topRocker) breeds angst in workforce .. 1/4 of 1% borrow window repriced to Labor force at 8%
      b> free money (or food stuff) increases the ability to breed a population* .. especially when incentives encourge breeding for a larger take check .. food stamp program altho humane – is not a free lunch to the whole (a gimme to more than the receiver – for there is always a seller)

      * stuff on this planet (fish running in schools from the trawler) (deep oil pumped) is NOT in an endless supply
      ** with good central management

  5. GeorgeBurnsWasRight says:

    Barry, to your third point, the Fed’s historic tendency for their forecasts to be too bullish, it’s been my opinion that this is neither incompetence nor accidental. If either of these causes was true, they would err on the side of pessimism about half the time.

    IMO, the Fed thinks that too much honesty about negative economic situations will by itself make the economy worse. So they turn into pollyannas for essentially political reasons.

  6. mutton says:

    A good example of what I read just last night in, “The Black Swan”

    • miamijim says:

      mutton: Most excellent point……THE best book out there!!!! Should be mandatory reading for undergrads/grads who live and breathe “Numbers” and models based on “past” performance.

  7. PeterR says:

    Chill, humanoids . . .

    I just had the Fed “jerk the lead” of the spoiled brat markets.

    More to come . . .

    2013 — A Space Odyssey

  8. VennData says:

    It was the irresponsibility in-over-his-head Bernanke, the horrifying Congressional Democrats and last and least but the biggest cause – Obama and his Socialist destruction, hatred of business, and not having business people – like floor traders – in his so-called administration … and his anger at business entertainment while he parties on drinks on our tax dollar!

    - Rick Santelli

  9. wally says:

    I like lalaland’s observation that the market behaves like “a school of fish”.

  10. rd says:

    In the middle of the recent action, it seems like the ETF market was not quite as liquid as the advertising would lead one to believe:


    I guess when you set up mutual funds to trade like stocks, every now and then they will actually trade like stocks instead of mutual funds.

    BTW – I didn’t hear Bernanke panicking – he was just mumbling stuff about how if the economy improves more then he can take away the heroin and methadone from the TBTF firms. However, I don’t think the addicts found that to be as comforting as most normal human beings did.

  11. neddyj says:

    Barry – I agree with your ‘excuse to sell’ theory that you laid out as well as that the reasons given for market moves the day after (and certainly now intra-day…always entertaining to me to watch the changing headlines on marketwatch try to encapsulate the day’s trading in an attention grabbing headline) often miss the point, for the stock market.

    The headlines barely pay attention to the bond market and currency markets…and aren’t they truly what ‘wags’ the stock market? Hard not to think that the Fed announcement was a ‘flashpoint’ for the rout in the bond market. They wanted to hear some ‘coo-ing’ after last fed statement….instead they got a squawk.

  12. Moss says:

    Seems like the market participants interpreted the Fed as being determined to cease this latest invocation of QE. That may be linked to Bernanke’s exit and possibly why the forecast seems a bit too rosy. Being able to cease would be the final chapter in Bernanke’s tenure and a mission accomplished banner.

    • None of which is news, or even new — so what was the causative factor that caused that OLD info to be the reason for yesterday’s selloff?

      • miamijim says:

        ‘Cause that’s what schooling fish and lemmings DO!!! Mass hysteria is chaos theory in action. Beware the Black Swan my little grasshopper.

      • flakester says:

        It doesn’t matter one whit. The only ones who care are those who weren’t short, or the behaviorally inclined.

  13. [...] While many market commentators were blaming Thursday’s declines on fears of the Federal Reserve tapering its asset-purchasing program, Barry Ritholtz is skeptical — and says the attempts to explain the declines highlight a big problem in investing.  [...]

  14. MayorQuimby says:

    It’s a form of laziness. It is far easier to gripe and play Monday morning QB than to burn some calories, think and try to look forward.

  15. Greg0658 says:

    besides above .. there will ALWAYS be a divy up OpSys .. the global workforce and transportation system has inserted a pipeline detour not seen in any other age (to the extent we see today)

    as nature always gets it way – this rebalance’g will happen – and the world will be One .. who will be the kingdom chiefs are in play .. and that (kings) will ALWAYS be in play – tis our game

    I’m sticking to game theory of the “Beaver Dam” as the gameboard** in the USA.
    Will the roads* hold up without a major reprice’g of road warrior labors?

    * paperwork pipelines
    ** or the dreaded but viable “Wash Rinse Repeat”

  16. Anonymous Jones says:

    What a great post. Cannot be emphasized enough.

  17. DeDude says:

    To me it seems like stocks often work on “hair triggers”. Everybody knew that we “should” be having a correction/fall for a lot of good reasons. Finally some little thing is added and trigger the fall. Was that little thing the trigger – yes, was it the course – hell no. Developments in bonds have been ongoing for several months as a lot of those who planned to stay in “until just before everybody else rush out” began to lose their nerves and got out. I think there is a fear of what will happen if rates were to jump 100bp within a few months – that fear gets exaggerated if people think the Fed might just allow it to happen.

  18. Lee Adler says:

    Blame China, Here’s Why http://wallstreetexaminer.com/2013/06/20/blame-china-heres-why/
    June 20, 2013
    Markets throughout the world cratered yesterday and today. The US, Asia, Europe, bonds, stocks, and precious metals especially got whacked. Wall Street pundits and opinion makers all blamed Bernanke’s dog and pony show yesterday. However, Bernankephobia is probably not the real reason for the massive wave of liquidation.

    This panicky selling has all the earmarks of a margin driven liquidation. The world’s second largest economy, China, has been undergoing a massive liquidity crunch in recent days as the central bank there maintains a tight monetary policy that has drained reserves from the system this year. The Chinese central bank, the People’s Bank of China (PBOC), has kept things tight in an attempt to bring the shadow banking system there to rein and to cool massive speculative bubbles. Of major media outlets only the New York Times has recognized the impact of the China credit crunch on the markets today, but even it blames the selloff on “concern” about it, rather than actual forced selling because of it.

    With the PBOC unwilling to ease the crunch, players in that system with assets abroad will raise cash to meet margin by selling whatever assets they can, wherever they can, particularly the world’s most liquid markets- US stocks and Treasuries. To the extent that they hold assets in those markets, they sell. This selling is significant enough at the margin to send asset prices crashing around the world, which triggers more margin calls in other assets, gold in particular, as well as in leveraged positions in US Treasuries and Treasury futures.

    This selling is in spite of the Bank of Japan and the Fed pumping massive amounts of cash into world markets. Just this week the Fed added $85 billion to the accounts of the Primary Dealers. The Bank of Japan continues to add billions each week as well. However, some players are simultaneously deleveraging, repaying LTRO loans from the ECB. That was probably the proximate cause of the initial selling in US Treasuries and other instruments earlier this year which may have set in motion a chain reaction that led straight to China, the most leveraged, bubblized system.

    Fed ECB and BoJ Drive Markets – Graph http://wallstreetexaminer.com/wp-content/gallery/economic-chart-gallery/fedecbboj.png

    According to Reuters, the PBOC injected a net of just 28 billion yuan ($4.57 billion) into their banking system this week. It has drained 198 billion yuan so far this year after injecting 1.438 trillion yuan in 2012. 1.4 trillion may sound like a lot, but it was on a base of over 29 trillion, so it was an increase of “only” 5%, which pales in comparison to the 35% the Fed is adding to its asset base this year.

    The PBOC’s draining actions along with the ECB allowing its balance sheet to shrink are counteracting the efforts of the Fed and BoJ to expand liquidity. While the Chinese financial system is mostly closed to the rest of the world, many of the players there transact business and do trades around the world. Whereas the Fed, ECB, BoJ, and Bank of England all pump (or drain) liquidity to the same world cash pool, some big Chinese players are playing in that pool and are siphoning liquidity. At the same time many players are deleveraging and draining liquidity from the pool to repay the ECB’s loans. Its balance sheet is shrinking at a breakneck pace. These actions and tight Chinese monetary policy are counteracting the liquidity pumping operations of the Fed and BoJ and are contributing to the instability we see today.

    On Thursday the PBOC refused to provide liquidity to China’s stricken markets. Panicked institutional traders were forced to sell whatever they could. We saw the results of that around the world. Some media reports today indicated that the PBOC had relented and provided targeted liquidity. If that is the beginning of a loosening of policy there to provide enough credit to end the forced selling of assets around the world, then the markets should find their footing and reverse. That’s a big if. It’s something we need to watch.

    Meanwhile, most of the rest of the big players around the world remain flush with cash thanks to the Fed and BoJ. That could be sufficient for the markets to mount a comeback, but the test will be for key support levels to hold in the US. If they don’t this could be the beginning of the endgame.

  19. Jim says:

    Storytelling is one of the earliest forms of effective human communication. The linking of events we have experienced to explain events we don’t understand goes back to the earliest humans and shaped the mythologies and religions of many tribes over the millennia.

    The complexity of all the interactions implied by the modern markets is beyond the comprehension of the human brain. We have not evolved to comprehend such complexity and our brain short circuits to our lizard brain. If we apply our thinking brain we can come up with analogies and analysis based upon the data but for most it is too complex to shift away from our inherent biases to accept the truth that hour to hour and day to day action is noise. We can find clues, hints and patterns that shift the probabilities of what is likely to occur in the future but as always we cannot know the future.

    Of course, when all else fails a simple answer can be found by following the money. The writers and pundits make their money by telling stories. As long as the narrative is plausible and the storyteller can generate views and the resulting advertising dollars then they will continue to get hired. (This is my lizard brain analysis.)

    A good synopsis of the brain and storytelling can be found here http://lifehacker.com/5965703/the-science-of-storytelling-why-telling-a-story-is-the-most-powerful-way-to-activate-our-brains

  20. Theravadin says:

    I agree with the cognitive issues you highlight, but I’m not so sure that they were “ex post”. I think that people were telling themselves those stories in the moment – that is to say, the market fell because that was the story people were telling themselves and each other. The market over short time periods, in a sense, is entirely about the story(s)… whether or not the story actually explains causal relationships that make any sort of sense. The existence of the story is the causal relationship. In my experience, in fact, the story (or spin, if you want to be brutal) is really all that is being valued by the market until you get to multi-year time spans. The market is therefore “efficient”, but efficient at valuing stories, not companies or economies.

  21. leopardtrader says:

    This is my view of where market is going after Bernanke comments. I completely agree with Barry here. http://leopardtrader.com/?page_id=1714