Ignore Short-Term Market Moves

Accrued Interest today has a great post about what really drives markets over short stretches of time. He uses the phrase "technicals", by which he means not drawing lines on charts, but rather the simple dynamics of how traders make and lift prices. And he has a slogan for the ages:

Trying to graft fundamental meaning on technical movement is a good way to be completely wrong.

This, of course, is what journalists do all the time. There are basically four ways that the market can behave: it can go up on good news, down on bad news, up on bad news, or down on good news. And when I say "on", I mean "after": journalists, concerned as they are with the news, invariably overestimate the importance of news in driving prices.

Portfolio's very own Jeff Cane put his finger on the ridiculousness of trying to draw causal connections, in a stock-market report he wrote on Tuesday:

A big bank announces a $3 billion write-down. Wal-Mart shows slow growth in same-store sales in the United States.
So stocks rocket, breaking a four-session slump, in a rally led by financial shares and Wal-Mart.
Huh?

"Huh?" is right. There's a simple lesson to be drawn from such stock-market behavior, and it's that markets are volatile and sometimes go in weird and unexpected directions. If you look at a chart of the stock market over time, the long-term ups and downs are clear, and equally clear is the fact that all those little zigs and zags along the way are basically irrelevant. So it's silly to fixate on a zig or a zag and try to explain its meaning.

So Cane gets two gold stars for his lede, but then loses one of them for this:

The write-down announced by Bank of America was not an unnerving, run-for-the-exit-doors event. Instead, the write-down was seen as a sign of a bank coming to grips with a known problem, the possibility of further write-downs having already been priced into the stock.

The fact is that no one has a clue what is "priced in" to any stock, with the possible exception of merger-arb candidates. As Jeff Matthews says,

Companies that comment on their stock valuation generally run towards single-digit NASDAQ shooters, not NYSE-listed mega-caps.

If companies don't know what's priced in to their own stock valuation, I can assure you that journalists don't know either. Yesterday, I spoke to the head of investor relations at a large financial institution which, impressively enough, is trading at an extremely healthy multiple of almost four times book value. Yet he still explained to me that the market wasn't fully valuing various bits of his institution's empire.

Of course, the market could start fully valuing the undervalued bits of the empire while still sending the stock downwards, just because there's no way of kowing what a reasonable multiple for this kind of institution should be. In other words, even the long-term trend can be very misleading: look at tech stocks in the late 1990s. Short-term trends, on the order of a day or two, almost never have much in the way of useful information. As a result, "what the stock market did today" reports should be of interest only to traders, never to long-term investors.