Do Stock Markets Care About News?

Does news impact stock prices? If yes, then for how long? Shohini Nath finds out whether the expectation about the movement in stock prices and the expected performance of the companies matter more than the current news in the long run! Read on….. 

Isn’t it surprising that the Indian equity markets are near their all-time highs, despite some disturbing news keeps making rounds? The president of the world’s most powerful country is being sued by a variety of people, the geopolitical tensions in Syria refuse to abate, the Indian rupee continues to depreciate along with other emerging market currencies, crude oil prices continue to inch up, trade war fears are real and keep making fresh headlines every other day, interest rate risk is imminent and many more such unnerving news keep investors on the tenterhooks. And yet markets keep inching up as if they give a damn to all the news. 

If markets are moving the way they are, ignoring the headlines that keep breaking every day, then why should an investor care about the headline news at all? Why is it that the stock markets nonchalantly ignore the news? If markets have a tendency to ignore the news, then what is it that matters more to the markets than the news? 

Expectations and not news matter more for equity markets

We have seen investors reacting to the news headlines umpteen number of times. Market reacts in different magnitudes to different news headlines. Markets will react less to the news that has been already factored in, while one can expect some violent moves in the markets to those headlines that have not been factored in. 

For example, markets may not react immediately in a negative fashion to inflation data and interest rate rise if it was already expecting it. However, a bomb blast or a terrorist attack or a natural calamity cannot be factored in by the markets and hence such news can impact the markets more forcefully. 

What we observe in general is that by the time any investor is able to process the information in the news and understand how it is going to impact the stock prices, markets would have already moved on, as if ignoring the news and attempting to look forward. This is the most difficult part of the markets, which investors ought to grapple with while participating in the markets. 

The barrage of information that keeps hitting the markets can overwhelm lot of investors. In today’s world, we will find that everyone has a view on everything, including where the market is headed. At the same time, there is constant search for objective answers – whether a stock is good or bad, whether markets will move up or down, etc. 

While investors want to know the good stocks from the bad stocks and are always in search of patterns that may repeat themselves, the trick that can really help investors create wealth in the markets lies in understanding if the situation is getting better or worse. Because it is ultimately the improvement or worsening of the market situation (outlook) that matters more than understanding if a stock is good or bad or if the market is going up or down on a particular day. 

While it is possible to label the market as good or bad depending on which variables you look at, it will be a profitable exercise if investors can ascertain whether the markets are expected to improve or get worse in times to come. In case the market situation (outlook) is expected to improve in spite of bad news hitting the markets, the stock prices can still go up. Similarly, if the market expects the situation to worsen, the stock prices can slide down in spite of good news hitting the markets. 

This probably explains why markets do not care for the news and are constantly analysing the information trying to estimate the forward direction by judging if the situation is improving or worsening. 

Market reaction to news and much more 

We looked at the Sensex data since 2010 and observed those periods where Sensex has cracked more than 5 percent at least. We find that there are at least 18 such instances when the Sensex has crashed more than 5 percent over 8 years. The table above highlights periods when the Sensex declined by more than 5 percent. The news that triggered the Sensex fall is also highlighted in the table. The rise in interest rates is found to have a higher impact on the stock prices in majority of the cases. 

What is interesting to note is the Sensex’s performance after each of these 5 percent or more corrections, i.e one year, two years, three years and five years down the line. Out of 17 times that the Sensex corrected by more than 5 percent, it has gone up on 12 occasions 1 years down the line and has delivered on an average 9 percent returns. The Sensex performance post the 5 percent correction improves as we increase the time horizon. The average performance of Sensex post 5 percent or more correction after 2 years, 3 years and 5 years is 24 percent, 42 percent and 68 percent, respectively. 

Conclusion 

Investors, while participating in the markets, ought to analyse the information swiftly and accurately. While doing so, the focus should not be on the news alone and one must not react to the news overly and in a knee-jerk fashion. The stock markets are forward-looking, and hence, investors should invest time in understanding the future expectation that the market is discounting and not react to the news in isolation. Clearly, it is evident that the overall markets react to the news in the short term and eventually move upwards. Rather than focusing on breaking news in such turbulent times, investors can start accumulating quality stocks as markets have shown a tendency to reward such brave long-term investors. Bad news can be a boon for the long term investors as such news depress the stock prices, thus allowing value investors to hunt for deeper discounts in the stocks. 

Any news pulling down the markets is an opportunity rather than a threat to the markets. Period.