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01 Jun 2013


Benjamin Graham, known as the father of value investing, espoused the use of fundamental analysis to calculate the intrinsic value of companies listed on stock exchanges. Improving economic fundamentals imply growing company earnings and should generally be positive for stock markets. But Graham often spoke about the market’s irrational behaviour. In today’s world of currency wars and massive monetary stimulus, markets have often contradicted what financial theory might suggest. PAUL CLUER looks at the recent phenomenon of when good news means bad news.

On Wednesday, 19 June 2013, the Chairman of the US Federal Reserve, Ben Bernanke, announced on behalf of the FOMC (Federal Open Market Committee) that the end was in sight for the US's quantitative easing programme that has dominated financial markets for half a decade. The FOMC based its decision on data that shows unequivocally that US economic growth is gaining traction and forecasts for continued growth are positive. By 30 June 2013, US GDP data is expected to have recorded 16 consecutive quarters of growth since Q3 2009, the end of the Global Financial Crisis-induced recession. The FOMC noted that the US labour market has shown "further improvement in recent months" and that the "downside risks to the outlook for the economy and the labour market have diminished since [the northern hemisphere autumn]".

So, a formal endorsement that the US economic recovery was both sustained and sustainable and that US unemployment was set to decline, spending to rise and house prices to sustainably improve is good news, right? Wrong. Markets in the US and other countries plunged on Thursday and Friday, 20 and 21 June. The Dow Jones in the US lost over 4% and Eurostoxx 50 lost over 7% of its value over the ensuing days. The yield on 10-year US Treasuries hit its highest since March 2012 at 2.36%, up sharply from 1.60% at the start of May. The gold price fell to its lowest level in nearly three years.

Why is this so? Markets were reacting negatively to Fed chairman's Ben Bernanke's comment that it would be "appropriate to moderate the monthly pace of purchases later this year" as long as the economy grows as expected. For the time being, the Fed said that it would continue its "QE3"policy of buying assets at a pace of $85 billion a month, and expects to keep interest rates low as long as the unemployment rate remains above 6.5%. But the markets are looking forward to the economic scenario the Fed anticipates, when the unemployment rate would likely be in the vicinity of 7%, with solid economic growth supporting further job gains." The fear is that this tapering of monetary stimulus would commence in the next few months.

Markets have therefore become addicted to this cocktail of stimulus and easy money and any hint of withdrawal has been met pessimistically by market participants - notwithstanding the fact that US economic fundamentals are improving and that everyone knew that the end of the stimulus must eventually come. But as if to prove that bad news can also be good news, on 26 June 2013 markets celebrated the disappointing downward revision of Q1 US GDP growth from 2.4% to a much lower 1.8% (annualised) by igniting a three-day rally as players bet that the Fed would maintain its stimulus just a little longer as a result.


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