Illogical Market Movements Are An Opportunity To Buy

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In his 1933 inaugural address, Franklin D. Roosevelt famously said “…the only thing we have to fear is fear itself.” That statement was particularly apt during the Depression, but it has always struck me that a large part of its truth lies in the fact that fear leads to illogical decisions. Anybody who seeks to exploit inefficiencies in markets, otherwise known as looking for value, is effectively looking for decisions and actions that, over time, will be shown to be illogical. Far from being afraid of fear, then, we should embrace it, at least in others. Yesterday the illogical decisions that fear brings were on full display.

Before the market opened we were treated to a second quarter GDP number that was even stronger than expected, showing that the U.S. economy grew by 4 percent from April to June. In some ways, despite beating estimates, a strong bounce back after a dismal Q1 number was to be expected, but dig a little deeper into the numbers and what we find is even better than the headline number suggests. Most of the increase was down to growth in personal consumption and private investment, while federal government spending declined 0.8 percent, effectively lowering the rate of increase. It can be dangerous to read too much into one quarter’s GDP number, but it would appear that the growth in consumer and business spending that we have been looking for is strong and after a long grind out of a terrible recession the economy is really picking up pace.

This is obviously good news and one would expect that to cause a huge rally in equity markets. It did... right up until the market opened.

SPXSPX

The initial reaction was logical enough as the S&P 500 jumped around 0.5 percent in the pre-market. On the open, however, the selling began and by noon we had lost almost a full percentage point from that opening print. At 2 pm the Federal Reserve Board’s Open Market Committee (FOMC) released the statement concerning their July meeting. In it they noted that “...growth in economic activity rebounded in the second quarter...” They also saw some improvement in the labor market, but overall continued weakness meant no change in policy or outlook. At that point, the S&P 500 jumped back towards the opening level.

If you have read Market Musings before, you may be aware that I rarely, if ever, pay much attention to intraday moves. That is mainly because, in the grand scheme of things, they usually tell us nothing useful. This time, however, is different. Both the seemingly illogical drop on good news and the recovery on the Fed’s “no change” announcement told us something important. It looks like we are heading back to the topsy-turvy world where what is good for the economy is bad for the market.

We have been here before. In fact the market spent most of last year seeing good news as bad, fearful that it would result in the Fed tightening policy. When there was a positive reaction to Ben Bernanke’s announcement in December of last year that tapering would begin it looked like much of the silliness was over, but all that happened was that the fear was transferred. Last year, fears were focused on the possibility of a reduction in asset purchases. Now that that is a reality, it is normalization of interest rates that is scaring traders.

Notice that I said traders, not investors. These fear driven moves tend to be very short lived and, as I have said many times before, should be seen as an opportunity by those with a longer term view. If traders are scared by the short term consequences of economic improvement and push prices down over the next few days, those with any cash left on the sidelines would do well to take the opportunity to put it to work.

Traders are trained to react to the prospect of higher interest rates by selling stocks, so the selloff following a strong GDP number can be seen as a normal reaction. The situation we are in, however, is not normal. A return to short term rates above zero has to come, but do you really believe that a more normal rate environment would hold back growth and investment for long in the face of the improving economy that caused it?. Don’t be fooled by the instinctive, fearful reaction of traders yesterday or over the next few days. Economic growth is a good thing and a signal to buy. If traders react with fear because of a possible short term consequence, then great... it just means that we can buy in a little lower. Don’t fear their fear.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Economy , US Markets

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Martin Tillier


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