What Moves Markets?

Tuesday, November 01, 2005 | 06:26 AM

In Lose the News, we asked:

"Have you ever noticed how the stock market reacts differently to the same reported events? Why is it that we sometimes sell off "in response to rising oil prices," but at other times the "market rallied, despite the rise in the price of crude" ?

How come a selloff was caused by a suicide bombing in Iraq, but a week later, the markets shrugged off an even larger, deadlier bombing? Is it possible that the markets are responding to forces other than the latest headlines?"

The WSJ's E.S. Browning  asked a similar question yesterday -- only the specific catalysts he reviewed were Washington D.C. scandals:

For the stock market, a big Washington scandal usually is little more than a tempest in a Teapot Dome. From President Harding's Teapot Dome scandal -- named for a Wyoming rock formation atop a misused government oil reserve -- through the Clinton impeachment, stocks have proved remarkably impervious to news that has roiled the political world.

It happened again last week. Thursday's stock tumble was influenced by reports that White House aide I. Lewis Libby was about to be indicted. But stocks quickly rebounded Friday even before the indictment was announced. Down 115 points on Thursday, the Dow Jones Industrial Average soared 172.82 points on Friday to 10402.77, up 187.55 points, or 1.8%, on the week.

Some of Friday's advance, certainly, reflected investor relief that the waiting was over and that Karl Rove, president Bush's political guru, wasn't indicted. But the investigation of White House leaks continues and Mr. Rove remains in legal jeopardy. When the indictment was announced during the day, the market fell, but just for a few minutes, before resuming its rise. Traders said Friday's gains appeared to have less to do with politics than with economics. They reflected pleasure that the government's report on third-quarter economic performance, also out Friday, included low inflation figures and good growth numbers.

And that is the way it usually goes with political scandals. Corporate profits, inflation and interest rates are what drive stock prices. Unless political news affects those things, by making a tax increase or an economic slowdown more likely, its impact on markets tends to be short-lived.

You can do alot worse than just those 3 drivers: Corporate profits, inflation and interest rates. Of course, I think its the interplay of those factors with Psychology that determines when P/E multiples expand -- and thats an even bigger driver of market returns.

Here's the Journal's look at numerous scandals and their subsequent market impact:
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click for larger chart
Wsj_scandal_10302005181606
graphic courtesy of WSJ

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Bottom line: Non-economic news events do not drive markets -- unless it is capable of causing significant Sentiment  shifts: Watergate, the waste of Viet Nam, the Carter malaise.

Over the past year, we have made note of the "statistical cheerfulness" of government releases. The underlying reason for the juiced data is simply to maintain this Sentiment above that crucial threshhold where psychology spills into the economy and the markets. 

Forget Supply Side Theory or Milton Friedman's Monetarism: The true economic philospohy of modern governments is "Don't Worry, Be Happy (and please keep on spending)."


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Source:
So, What Really Drives the Stock Market?
Politics Certainly Can Play Role, But From Teapot to CIA Leaks, Economy Has Had Lasting Impact
E.S. BROWNING
THE WALL STREET JOURNAL, October 31, 2005; Page C1
http://online.wsj.com/article/SB113071379795783709.html

Tuesday, November 01, 2005 | 06:26 AM | Permalink | Comments (7) | TrackBack (0)
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Comments

I remember your post about the multiple expansion vs. the lack of earnings growth because in the last couple of years I have been doing that same analysis.

My conclusion is that the multiple expansion is linked to the strong US dollar. Charts show that multiple expansions occured around 1995 just as the dollar took off. The whole world wanted to invest in the US.

Technology and the New Economy were the new mantra. The world became mesmerized by US creativity and its growth opportunities. The bubble imploded in 2000 but markets are still afraid to bet against the US. They still want to believe in the US machine.

But with all the imbalances out there, something is bound to happen and I wonder if a lower dollar would bring down the multiples.

Posted by: D. | Nov 1, 2005 9:43:16 AM

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