I once heard a TV talking head say “the market was wrong…”
He was talking about the market’s rally in the face of what would otherwise be a bearish economic report.
He should’ve been fired on the spot and reassigned to paper hat duty at the station’s cafetaria.
Here’s the unvarnished truth.
The market is never wrong.
I don’t care what you think it should be doing, You can build the most rock solid case of why it should be heading lower — if the market is rallying, you need to rethink your ideas.
There are a lot of reasons why markets will move in seemingly illogical ways. Today I want to talk about one of them…
The Truth About Economic Reports
Every week all kinds of economic reports are released. They’re released by branches of the government, from the Federal Reserve, from private economic research institutes… But here’s the thing about all of them:
An economic report doesn’t matter until it matters, and then only matters if it matters.
Here’s an example… Back in the early 80s, there was a report called money supply that measured the amount of money (in its various forms) that was in circulation. It was reported every Thursday at 4PM ET. The S&P 500 futures market closed at 4:15PM ET.
If the reported number was out of line with expected consensus, the market had the potential to go nuts with traders everywhere firing in futures orders to hedge the following day’s open.
It was an important report back then because, at the time, it was widely considered the Fed’s job to manage inflation by controlling the amount of money in the financial system.
Today, with the Fed’s new role as the great printer of money to monetize all kinds of financial assets, money supply is pretty much a non-thing. They still track it but nobody cares…
So did the monetarist theory of money and inflation suddenly become irrelevant?
No, it didn’t.
So if it hasn’t, shouldn’t a chart like this be sending the market into Defcon Level 1?
United States Money Supply M1
No. It’s just that the market has decided that it no longer matters and now chooses to focus on other data.
Magic Economic Reports
The market is going to listen to what it’s going to listen to. (Or maybe said a little differently for you parents out there, like your kids, the market is going to hear what it wants to hear.)
The threat of inflation hasn’t gone away. The difference these days is we’re obsessing over other reports like the Consumer Price Index (CPI), Personal Consumption Expenditures (PCE), and hourly earnings.
These are all economic data that, theoretically, can indicate or impact inflation. But these reports come with a couple advantages.
First the data can be… well, “fudged.”
For example, the CPI number is specifically called “Headline CPI” to differentiate it from what the Bureau of Labor Statistics (BLS) considers a more important measure they call “Core CPI.” The difference between the measures is that Core CPI has removed a couple items they say increase volatility in the index… namely food and energy prices.
Sorry, but if you stop spending on food and energy you’re pretty much dead.
Another tweak is called the substitution effect. When one item becomes too expensive, they’ll substitute something cheaper in its place. Now the BLS firmly denies that it does this to lower the impact of rising prices in its index. But on their own website they admit:
“In January 1999, the BLS began using a geometric mean formula in the CPI that reflects the fact that consumers shift their purchases toward products that have fallen in relative price.”
If you have trouble understanding that, congratulations, mission accomplished.
Then there’s hedonic modeling. Say your new Macbook cost you $1,000 more than your last one did. CPI calculates the increase in price as less, because the technological advances built into it give you waaaaay more value.
Again, the BLS denies they’re fudging but they say:
“Hedonic modeling is just one of many methods that the BLS uses to determine what portion of a price difference is viewed by consumers as reflecting quality differences.”
I’m not suggesting that these economic reports are totally rigged, but they do have the potential to contain a little bias. And doesn’t that make them pretty much useless on their face?
So What Should You Make of Economic Reports?
There are a couple things you should remember when it comes to economic reports…
First you have to understand that the Fed — and not necessarily reports on the state of the economy — is currently the largest driving force in the market today.
Second, understand that the market is forward looking. If it reacts unexpectedly to an individual economic report, it has probably already discounted the current news and is looking further ahead.
Number three… It’s more important to watch the TREND. Economic trends are more important than any single report.
And finally, most importantly, the market is NEVER wrong!
Make the trend your friend,
Co-founder, Streetlight Equity