Shouldn’t Good News Make the Market Go Up?

Sam Swift

Jun 5, 2018

Shouldn’t Good News Make the Market Go Up?

As the Dow and S&P went on their (completely normal) volatility rides earlier this year, I noticed a common misperception about the market gaining traction again. It was actually tweeted out by someone going by @realdonaldtrump (never heard of the guy but he has almost 48 million followers so maybe I should start paying attention—might be a real newsmaker):

“In the ‘old days’, when good news was reported, the Stock Market would go up. Today, when good news is reported, the Stock Market goes down. Big mistake, and we have so much good (great) news about the economy!”

This is actually not true. Sixty years of academic studies tell us that market prices are reflective of all publicly available information and investor expectations.  Given that, it follows that prices change for one of two reasons:

  1. New information enters the market
  2. Investor expectations change

Both of these things happen constantly which is why market prices are changing every second. If market prices were only determined by new information, then it would be reasonable that good news should drive prices up. It’s that pesky second rule that changes the equation.

You can find headlines that go something like this all the time: “Company X Sees Stock Price Drop as Q2 Earnings Miss Expectations”. Let’s say in this example that Company X had $1.3 billion in Q2 earnings which was a record-breaking quarter and undeniably good news. However, if investors had priced in that Company X was likely going to have $1.5 billion in Q2 revenue, then good news is still disappointing news and the stock price can drop. If investors are purchasing a stock at a price that assumes incredible news is coming, then simply good news can cause that price to fall.

This happens the other way as well: “Wall Street Bank Sees Stock Price Bounce Back After $900 million Fraud Settlement.” How can a fraud settlement (bad news) make a stock price go up? Investors may have been expecting a much larger fine or may just be pleased to see the uncertainty of that liability eliminated.

So back to the tweet and why it matters. The fallacy inherent in thinking prices always go up with good news is that in order to succeed, you just have to pick the best companies. With some serious time and effort, that can actually be done—successfully predicting good or bad news is hard, but not impossible, and it makes a lot of people think they can beat the market and get ahead. The catch is that this alone won’t make you a genius stock picker. You not only have to predict the future, but you have to predict how investors will react to that future and evidence shows us that’s nearly impossible to do over a long time period.

 

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