One of the more counter-intuitive aspects of stock market investment is the topsy-turvy relationship between the news and the markets. Sometimes good news is simply that and bad news is also what it seems. At other times, however, good news is bad for investors while apparently disappointing news can be a positive. There is a logic but at first glance it can seem perverse.
It’s always been the case that the main driver of an investment in the short term is not what happens but how that reality compares with expectations. Because of this, a share can enjoy a big bounce on the day a company announces poor results. If the market expected something even worse, the announcement might prompt a relief rally. Equally, a decent set of numbers can send a share price into reverse if investors had hoped for something even better.
This, by the way, is why it is usual during earnings season for a relatively high proportion of companies to beat analysts’ forecasts. It just means that their investor relations departments have done a good job of managing down expectations. You should assume that 70pc of companies will announce figures ahead of the consensus and worry if it’s much less than this.
In recent years, however, there has been a different good news/bad news dynamic at work and this one is all about the influence of central banks on the direction of stock markets. The US Federal Reserve (Fed) and its counterparts in Europe and Japan long ago stopped being simply the referees but became the game’s star players. This is not how it should be.
The importance of central banks to the markets has been evident for a while. It is 25 years since the Russian debt crisis and collapse of the Long-Term Capital Management hedge fund set the stage for Alan Greenspan to adopt the role of financial market ‘maestro’, riding to the rescue whenever things got sticky for investors.
But the importance of the rate-setters really took off in response to the financial crisis of 2008. This is when bad news started to be welcomed by investors. They came to realise that the Fed could be relied on to respond, Pavlov-style, to a slowing economy, gummed up financial plumbing or just simply a falling stock market.
A put option is a derivative contract that makes an investor money when things go wrong. Unsurprisingly, the willingness of central banks to bail out investors with lower interest rates or other forms of stimulus such as quantitative easing came to be known as the Fed Put.
For ten years from 2009 to 2019 this Fed Put meant bad news was invariably good for markets. Sluggish growth and rolling crises in Eurozone sovereign debt or the Chinese currency or a negative shock such as Brexit provided central banks with the cover to keep interest rates on the floor. If you owned assets or needed to borrow money you were happy. If you wanted to generate an income, you were rather less so.
Then along came the pandemic and the ‘bad news is good’ narrative was turned on its head, once again by massive government interference in the normal functioning of the market. Lockdowns and fiscal stimulus respectively crimped supply and boosted demand in the economy. Unsurprisingly, inflation started to take off. The invasion of Ukraine a year ago tomorrow merely poured fuel on an already smouldering fire.
So, we now find ourselves in the opposite situation from that which characterised the pre-pandemic bad is good world. Now investors view good news as bad because they fear that better-than-expected economic data will provide central banks with the justification to keep rates higher for longer. Fearful of letting inflation spin out of control on their watch, this is their default position. Understandably so.
And there is plenty of good news right now. First, we had evidence that the US jobs market remains red hot despite the Fed’s efforts to douse it with cold water. Last month’s non-farm payroll numbers were off the scale, while January’s retail sales figures were much better than forecast. No surprise that so too were both consumer and producer prices data.
This week it was Europe’s turn to surprise on the upside with business activity in the Eurozone recovering more quickly than expected in February. Growth in the region has hit a nine-month high as the predicted energy crisis fails to materialise. No wonder that expectations for the peak in European interest rates keep rising. Negative rates are a dim and distant memory now.
The markets always looked to be over-optimistic about the expected trajectory of interest rates with Jay Powell almost blue in the face as he tried to persuade investors that he was serious about getting ahead of inflation. The more than 15pc recovery in share prices since the October low felt ambitious and premature.
So, a more likely scenario is now that shares will bounce along the bottom while the market, economy and corporate earnings become better aligned. The good news about this excess of good news, if that makes sense, is that the October low should now hold. The earnings recession could be milder than feared this year and the debate about whether we should expect a soft or a hard landing may be moot. Perhaps it really will be no landing at all.
What seems like bad news for investors - they turned up too early for the recovery - could turn out to be good news after all. A year of volatile but ultimately flat markets may not feel very exciting but it will provide plenty of opportunities to make sure you are fully invested when the rally finally comes along.
Tom Stevenson is an investment director at Fidelity International. The views are his own.
