Why Stock Markets React Negatively to Positive News

Is the market reaction more to do with the nervousness around expensive stocks? Or can we expect a change to corporate profitability?

Dan Kemp 7 February, 2018 | 7:07AM
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how the S&P 500 has fallen volatility stock market

US stocks listed on the Dow Jones, S&P 500 and tech-focused Nasdaq markets have all fallen since their all-time highs late last month, although they finished yesterday in the black. Ironically, if market headlines are to be believed, the fall was in reaction to stronger employment figures released last Friday, where the market is now thought to be concerned that the jobs figures are too good and will force the central bank to raise interest rates faster and higher than predicted. 

By applying perspective, one must remember that the U.S. jobs figures showed the highest wage growth in eight years, not the weakest. So, it seems rather ironic that it would be the catalyst for investor panic, as it is something the market had desired for so long. This highlights how hard it is to explain sentimental shifts and reinforces the need to focus on valuations.

Therefore, under this framework, it is important to look through why the investor reaction was so pronounced, which is best considered under the lens of price versus fundamental change.

For example, is the market reaction more to do with the nervousness extending from the stellar bull market of 2009 to 2017? Or can we expect a material impact to corporate profitability? While we are not in the business of forecasting short-term sentiment, we can assess this relative to current prices, where U.S. equities have been considered as overvalued for some time now.

We can also apply thought to the evidence, which overwhelming shows that prices are more likely to fall back in line with fundamentals, especially when prices run well ahead of intrinsic value.

What is the Best Course of Action?

Before being tempted to act, investors should acknowledge that periods of market turbulence can be especially dangerous as they tend to elicit an emotional response and heighten the behavioural biases to which we are all prone. Left unchecked, these biases can lead to us making poor decisions which can harm long term investment returns.

We therefore need to find a way to overcome these biases, which should include the following:

First, remember that investing is a long-term pursuit and put all recent price movements in this context. While a 5-10% fall may feel a lot, it means little in the context of a 10-year investment horizon.

Second, try to avoid the sensational headlines that can lure you in to action. It is normally better to read books than listen to forecasts.

Third, if you are going to look for opportunities, ensure that you have a robust framework for assessing the real value of assets. This will put the wage growth in perspective, providing an anchor for your expectations and help you avoid over-reacting to short-term price movement.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Dan Kemp

Dan Kemp  is Chief Investment Officer, Morningstar Investment Management EMEA

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