We are told that markets are ignoring news flow today in the hunt for short term gains. In part this seems to be an issue of salience. The news which ‘feels’ more important is that which grabs the headlines: Korean missile tests, the unwinding (or not) of QE, and the Catalan independence vote are examples of this. As behavioural economist Cass Sunstein has noted, when the news is scary, we tend to pay more attention to it.
We therefore find it surprising when markets don’t have a greater reaction to these events. In a recent interview, even behavioural economist Richard Thaler, who has worked closely with Sunstein, admitted as much himself:
The problem is that the ‘news’ which impacts markets doesn’t always fall into the headline-grabbing category. Some news is more boring, and only changes gradually, but it is this news that often matters most. Global profits growth falls into this category, and as noted in a recent article in The Atlantic, this has been strong almost everywhere this year, after having been weak in 2016:
This is why some markets, like Korea, have not got more expensive despite significant price gains. Earnings have been going up at least as much as prices, but this garners less attention than headlines about all-time highs in the index.
Global macro dynamics have also been positive (shown in figure three by a composite indicator capturing a range of different indicators):
So it is not clear that markets are ignoring news. It’s just that we have a skewed sense of the nature of news that has been coming out because the bad, frightening news gains more of our attention than the duller, slowly evolving data.
It is also the case that we can also never know the counterfactual; it could well be that South Korean equity markets would be up a lot more if there had not been missile tests by the North.
Even though markets may not be behaving as irrationally as they first appear, there is nevertheless information in what type of information the market is choosing to pay attention to.
The Catalonian independence vote is a case in point. Events in Spain have had an impact on markets; see for example the recent underperformance of Spanish equity relative to Italian…
…and in differential behaviour in short dated government bonds directly after the vote:
What is significant, however, is how contained market moves have been thus far. Price moves have been limited to Spain itself (and even to particular assets within Spain).
Again, we can never know for sure, but it seems likely that had the same events taken place between 2010 and 2014 we could have expected far more contagion in other European assets. Consider the extent to which Greek events had a correlating impact on markets across the continent.
This is a reflection of both sentiment and fundamentals, which are clearly interlinked. The European economy and banking system are in a better place today, but investors around the world also seem to be more discerning in their treatment of assets. A note this month highlighted that correlations between the US markets’ largest 50 stocks were at their lowest level since 2000, while cross asset correlations are also at relatively low levels.
It remains to be seen whether this environment continues; you do not normally have to wait too long for correlating shocks to hit markets. It is also the case that if fundamental news itself is correlated, as is largely the case with positive aggregate global earnings and growth data today, it is very hard to make bold pronouncements about just how discerning investors are being.
However, these should be encouraging signs for active investors, and run contrary to prevailing narrative that low volatility and strong gains across a wide range of equity markets over the last year mean that all assets are being driven by the same factor (QE, the rise of passives, and straightforward ‘bubbles’ are the most common candidates). Moreover, after a decade in which ‘risk on-risk off’ behaviour has seemed to dominate, any signs of more idiosyncratic drivers of return are welcome.