When bad news is good news and challenges textbook learning
• Bad news is increasingly digested by the market with the expectation of a positive outcome
The saying normally goes “no news is good news” when it comes to everyday life. I think the adage works because without any news of any kind, it probably gives us less to worry about unnecessarily, and for the most part things will unfold as they should and turn out fine.
As a scholar of the capital markets over the past 20 years, I recognise that information and the transmission of it plays a crucially important role in the healthy functioning of the system. As I set out on my career, good news about an instrument or asset class generally resulted in a positive outcome for the share price and vice versa.
Since the global financial crisis of 2008, there has been enough to challenge this and other aspects in our university economics and finance textbooks. Negative bond yields, modern monetary theory and oh, by the way, negative oil futures prices which can and have happened are some of these phenomena that give one pause for thought from thinking what can possibly happen next. A dangerous question, I should know better than to ask.
Over and above these phenomena the two that interest me the most are the nature of financial market crashes and that bad news is increasingly digested by the market with the expectation of a resulting positive outcome (especially since the start of the global financial crisis).
The reason market crashes interest me so much is that they are extremely instructive, are occurring more frequently and that we are almost formulaic in our response. If you ever wondered why the principal structure, mechanisms and even regulatory frameworks surrounding our capital market system look the way they do, you are in good company, but the answer may surprise you. From the earliest market crash recorded, the aftermath of each is normally accompanied by temporary remedies which, in the passage of time, become permanent features.
When you think about central banks, stock exchanges and various regulations; one may be forgiven for thinking that these were carefully conceived and constructed by the leading minds across time, all huddled in a room.
The temporary remedy from the global financial crisis, which a decade later enjoys looming permanence, is the coordinated and unprecedented policy response mechanism (with a small dose of tightening respite in between). It is this mechanism that has helped reprice risk, periodically distort the expected relationship between risk and return and turn the market into a mechanism that digests bad news rather well, anticipating a policy response that more than offsets the original implications of the bad news itself.
There are two kinds of policy responses: monetary and fiscal. This past week our own monetary policy committee sustained rates at 3.5% with the implied policy rate path of the quarterly projection model indicating no further rate changes in the near term.
Looking north and over the Atlantic, the Fed has stated that it expects to keep policy rates near zero for at least the next three years and warned any rebound or recovery could be at risk without more government spending, the fiscal response.
This also throws a little asymmetry into the system as any recovery or rebound (good news) needs to meet high and stricter standards before policy accommodation can come to an end.
While monetary policy is a mechanism that is limited in what it may achieve as a form of stimulus (barring quantitative easing iterations), we may celebrate some bad news keeping rates lower for longer, but it doesn’t fully solve the whole problem.
Fiscal policy, on the other hand, is a completely different issue. When it is deployed in this kind of quantum, it can achieve any level of spending or income that is desired in an economic system.
The use of co-ordinated fiscal and monetary policy to achieve desired economic outcomes continues to reinforce the market’s behaviour and attitude towards risk in an asymmetric manner.
One may feel as if good news would then have a direct and opposite effect, but given that the conditions for a rebound and recovery may be stricter good news may at best be benign for the time being.
While the lion’s share of this kind of activity and scale has occurred with our developed market neighbours, because of the interconnectedness of the financial markets and economic systems these operations do have an effect on our local markets. SA, I concede, has its own set of other intrinsic challenges, but I remain hopeful and optimistic that we will overcome them.
The capital market ecosystem is complex and given that permanence from postcrisis remedies are expected to endure, these mechanisms are likely to provide many opportunities for seasoned and experienced investment professionals. This should unfold in good news for investors over the long term.
THE AFTERMATH OF A MARKET CRASH IS ACCOMPANIED BY TEMPORARY REMEDIES WHICH BECOME PERMANENT