Trading Complex News
Simplicity Comes Later
This week has seen traders increasingly confused by conflicting news stories and price action. On the one hand the news points to increasing trade tensions, but on the other (and partly as a consequence) it offers hope of a much needed resolution to avoid the fateful international relations meltdown of October 1987. This uncertainty or tension is reflected by erratic two way volatility in stocks and yields but is seemingly ignored by a partially resurgent Dollar and weak commodities.
Such an apparent conflict is actually instructive as it fits in perfectly with our 1987 template. Deteriorating international relations were a key part of the crash – and indeed the lead in rally – and are having a similar effect in 2018. With such a bullish backdrop, bad news causes a sharp but temporary drop and any hope of resolution or agreement drives prices higher again. Dollar Pairs also fit into the picture quite well as the US dollar made a multi-month rally before the 1987 crash and turned lower again in advance of stocks.
Yet while price action is fairly simple to track and compare, the reality back in 1987 and indeed now is far more complex. Few historians blame the 1929 and 1987 crashes on geopolitical tensions, choosing instead to focus more on one of the other causes and ignoring the unique combination of factors that is repeating itself in 2018. It is the nature of commentators or indeed humans to simplify complex situations into understandable if not actionable scenarios.
But sometimes this simplification is wrong. Sometimes the situation or combination of factors is so complex or uncertain that traders feel unable to act with confidence and the market only really moves once there is clarity or resolution. Acting before a resolution can prove to be wrong.
This week’s newsletter seeks to explain how and why news can impact complex situations and markets in both the short and medium term—with an inevitable conclusion. One size never FITS all unless it has fitted before.The similarity to 1987 and 1929 to 2018 remains one of the most stunning complex comparisons we have ever seen. But perhaps more importantly, next week we will show how that complexity can be translated into effective analysis and trading strategy.
The effect news has on markets depends partly on the extent to which it affects those influences that are seen to be driving the market. If stock traders are preoccupied by earnings or forex traders by trade balances they may turn a part or complete blind eye to inflation reports that were previously regarded as important.
The extent that news really does move markets in the short term and medium depends on a set of complex variables that are also subject to change over time. This begs complex questions such as how one news items fits into a related narrative, the relationship of the news to variables that are driving the market and how that in turn affects or, possibly more important, is seen to affect the drivers that in turn leads to trading decisions.
Get the drift? The impact of news on markets is extremely complex dynamic and subject to a variable probability set. So should we bother? Technicians would argue no, but even a chart with context and a narrative is much more useful than one without. Indeed If these relationships can be simplified and understood to a point where possibilities become actual probabilities then we would be foolish to ignore them – even if that means we use news narratives or events only to bolster or reduce our existing trading strategies.
The Complex News Story
People tend to think of news as a one-time event. Yet this is more the exception than the rule as particular news often fits into a stream or narrative. This is even true of self contained economic releases as an inflation release will be seen in the context of the recent trend of CPIs and monetary policy. An outrageous beat or miss may possibly be ignored or its impact restricted to the short term because it is regarded as an exception rather than a new trend… unless of course it is verified by subsequent or related releases.
Both the overall narrative and the individual stories that contribute to that narrative are subject to a cycle. Assuming the news or narrative proves to be noteworthy and ultimately moves the market significantly, it tends to follow a typical cycle depending on its coverage and therefore the awareness of traders and therefore a typical impact on price.
Initially news tends to have a relatively low impact due to low credibility and therefore either commentators ignore it and traders miss it. Trump tariffs are a good example. The President threatened during the 2016 election campaign to raise tariffs on Mexico and China, specifically, to help American manufacturers. Even in a 2011 book titled “Time to Get Tough,” Trump floated the idea that taxes on imports should be raised as high as 20 percent. So tariffs were always a Trump possibility. But it was only in December 2017 that tariff rumblings became more of a probability even though the market chose to ignore it. And 24 days before the actual tariff announcement on February 12th it became clear the Trump Administration was serious. But even then it was largely ignored.
Once the news is seen to be important there will frequently be reports that either heighten or reduce its credibility and/or significance. You would be justified in believing protectionism is the story of 2018 and ultimately the trigger for a 2018 stock market crash, bond ramp and Dollar collapse. But there have been times when you could be forgiven for believing it is either a storm in a tea cup or about to be resolved peacefully. Either way from a price perspective the market remains effectively unchanged.
Why then can significant news provoke a little, or confused or even worse a counter-intuitive reaction in the market?
There are 4 reasons and again tariffs provide a good example. The first is that the stream of news has itself been confusing with the US administration vacillating between a lukewarm and an aggressive protectionist stance and, with the threat of reprisals, a more conciliatory approach.
The second is perhaps more surprising that the ultimate impact on market is not clear.
The third reason is that tariffs is not the only news narrative out there. In our opinion the three main drivers of US stock markets are the trade war, US monetary policy and disinflationary growth. Even presuming they all point the market in a similar direction, the flow and interaction of varying news can cloud interpretations and distort price action.
Now add narratives that conflict such as bullish inflationary growth versus bearish protectionism in the longer term, and it becomes increasingly complicated. Any trend, if one emerges at all, is subject to more volatile news driven two-way price action.
More often than not the market lacks trend and becomes trapped in a range. However if one of the driving narratives starts to fade or is resolved, then it quite often triggers a break of the range. It can be thought of as the trilemma shown below, with only two of the three possible at the same time.
- Price trend
- Bulllish inflationary growth
- Bearish protectionisim
Therefore while points 2 and 3 exist, trend is absent. This is especially noticeable in the Dow Jones where protectionism has a larger impact. Take away the trade war and the Dow would be set free.
We can compare this weight to a smaller scale event when the North Korean threat failed to materialise on a September weekend 2017 (non-news), allowing the bullish Trump news narrative to produce an aggressive break higher. Could we be looking at a similar situation with a no news tariff event? Certainly the market has a similar feel if not look.
We are realistically and intentionally painting a very complex picture of how news affects stock markets.
But now consider the foreign exchange markets where you have two countries news streams, more variables and probably more external influences besides. The picture becomes even more fragmented and partly explains the increasing short term nature of global markets and why so many news influenced traders treat each day as it comes. One could reasonably argue the reason why forex markets seem to trend less and consolidate more than stocks is because the fundamental and associated news stream counterbalance themselves more.
And yet it could also explain why, when one key news narrative is resolved the associated move out of a forex stasis or equilibrium range is even more aggressive. One of the biggest ironies of this decade was how, despite all the bearish Greek news, the Euro only broke down in 2014 when the Greek crisis seemed to be abating as they returned to the bond markets and Fitch upgraded their debt.
The fourth and arguably most important reason why news doesn’t always translate into the most obvious price action is sentiment and consequent market positions. This will be the subject of next week’s newsletter as it is only really with a true understanding of what the market expects from the news that we can truly predict how it will react. It is only by distilling complex news and sentiment into simple price action that we can predict what the market will do.
News is complex. Market interpretation is often confused. Yet price action is relatively clear and simple. And is why we can devise relative clear and simple trading strategies to exploit news opportunities.
Here’s to making the very best.
To receive our weekly articles by email in advance of publication, please sign up for our Sunday newsletter.