Should you freak-out about the world? Look to the markets

I remember it clearly. It was a dreary winter’s night in the Sydney CBD and I was attending a seminar about what to expect from a career in finance.

I was staring down the barrel of a three-year post-graduate finance course. Did I really want to do this?

Then the presenter said something to me that really resonated. He said, ‘do you know who gets news first?’ I thought, ‘I haven’t a clue’. Maybe the prime minister? Maybe the police??

It turns out financial markets get the news first. That means stockbrokers, financial planners, investment banks, or traders… anyone with access to a news wire (Reuters, APTN) will get the news first.

That was exciting to me. From there, I was hooked.

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So how does it work in practice?

The mechanics

So, here’s how it works: something happens, news breaks. It could be anything from a house fire, to a ferry sinking in the Mediterranean Sea. As tragic as these events are though, they don’t tend to influence financial markets.

Events like the collapse of the World Trade Centres, or the election of Donald Trump as president of the United States, however, most certainly do.

Journalists who work for the “wires” (mentioned above) are the first on the scene, or the first to write “copy”. They will report the initial event. It usually lacks detail but it’s enough to get a broad sense of what’s happened (or is happening).

Market participants read that information, usually just minutes after the event has occurred, and may make a trade based on that – depending, of course, on how they believe the event will influence the world.

Obvious examples

Immediately after the BP Deepwater Horizon oil spill, the BP share price crashed because of the obvious costs involved.

In the case of the 9/11 attacks, no one really knew what it meant for world politics, so a broad “sell” order was given and stocks slumped across the globe.

One of the biggest market collapses occurred when the giant US investment bank, Lehman Brothers, went bust – largely because of the obvious implications it had for credit markets around the world.

When news breaks, financial markets digest the news first, and make a call on what it means.

Modern history

Over the past 12 months we have experienced two major world events.

The first was the election of Donald Trump as president of the United States. The second was the build-up of geo-political tensions between North Korea and the United States.

Stocks sold off following the announcement that Donald Trump had won the US election, but, in an amazing turnaround, they rebounded when the president promised big tax cuts and infrastructure spending plans.

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The market reaction to the US president was a prelude to what was to come… lots of drama, volatility, and uncertainty.

As far as North Korea is concerned, the market reaction was also correct. Stocks didn’t budge initially, but as the crisis worsened, and North Korea threatened to act by mid-August, markets began to get nervous.

AMP chief economist Shane Oliver told me on the Friday evening of the 11^th of August, that markets were as nervous as they had ever been about the crisis.

There was some cause for reflection, however. You see during the Cuban Missile Crisis in 1962, the Dow Jones Industrial Average fell as much as 7 per cent. Throughout this latest crisis, stocks haven’t moved anywhere close to that. What does that tell you? That markets simply haven’t taken what either leaders have said too seriously. So far, that’s been a fair call.

That’s not to say nothing will happen. Markets, however, have good memories, and they make a judgement call each and every time something happens, to determine the severity of the threat – then make a decision as to how to act.

Markets not fool proof

We’ve established that the financial markets will react to a news event first, and the “gut” reaction is usually spot on. However, markets do get it wrong. They overreact and underreact.

The thing to remember though is that it’s money that leads markets. Generally speaking, when traders make decisions, it’s their money, or their clients’ money, on the line. They’re therefore not going to make reckless decisions.

Some market reactions second-guess implications of events, and misjudge events entirely, but on the whole, they do their best to get it right.

When real money can be won or lost, traders will think very carefully whether an event is worth freaking out about or not.

David Taylor
@DavidTaylorABC ‏