There is no doubt that we are now at a time when, economically, nothing is going as it should. The time when you could adjust your expectations and assessments overnight. However, recent US inflation data show why this should not be done.
Because now it looks like the stock market could soar even with the bad news. Investors who liquidated positions or even shortened stocks after hot inflation data are likely to be annoyed. But what are the causes of this phenomenon?
future versus past
The main reason why stocks can skyrocket on bad news is because all media messages are backward. While they may have an impact in the near future, this is not necessarily the case.
The stock markets, on the other hand, are completely focused on the future. The bad things that happened yesterday are completely ignored, as long as they have no bearing on the future. This is also visible in the hot US inflation data.
There is no doubt that inflation in June at 9.1% was again much higher than experts had expected. However, lower energy prices are not yet reflected in these figures. It will probably become visible only after the July inflation data. The growing stock market, of course, anticipates this.
Uncertainty worse than bad news?
This behavioral psychology phenomenon is very often recognizable on stock exchanges. Suppose in a political decision-making process such as an election there are three possible scenarios for the stock market: best case, baseline, and worst case. Then it may be that while bad news is the worst case scenario, prices continue to rise.
The main reason for this is that markets can absorb some negative facts better than the sword of Damocles that hovers constantly over the markets. Because from the moment the worst-case scenario is sure to happen, you can combine all your strengths and work so that it doesn’t get as bad as you fear. This phenomenon could be observed recently during the course after the Brexit vote. After a short shock, the markets recovered very quickly.
central bank interventions
Particularly with central bank decisions, the reaction of the stock markets becomes extremely irrational and unexplored for private investors. Since it depends on individual economic data whether central banks raise key interest rates or leave them low, exchanges usually always want bad news.
Because then the risk of interest rate increases decreases and stock exchanges can continue to play with cheap money. In this case, however, the bad news is also not good, as it indicates a cooling down of the economy. As a private investor, it is difficult to predict the reaction of stock exchanges.
The belief that you are smarter than the financial markets can cost you dearly. Because markets are often irrational to the news at first. There may be times when the stocks go up on bad news and go down for good. Predicting market behavior is impossible in the long run.
I believe that maintaining confidence in a diversified portfolio in the face of the bad news will yield higher returns in the long run. The constant buying and selling only fills the broker’s pockets at the end of the day. As such, you should take the time to select the right stocks or ETFs, rather than trying to measure time in the market.
Bad news article? That’s why the stock markets keep growing! he first appeared in The Motley Fool Germany.
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