Market reactions do not always make sense at first glance. A strong result can be followed by selling, while a major announcement can land with very little movement.
When I see a reaction like that, I want to know what investors were expecting before the announcement. They have usually been forming a view and positioning around it for some time. By the time the news arrives, the price may already reflect part of the response. That is what we mean when we say something has been priced in.
Consider an inflation release. If the market has spent several days expecting a higher number, some of the response may already be visible beforehand. The dollar may have strengthened or bond yields may have moved as investors adjusted their positions around that view.
When the actual number arrives, the market is therefore not starting from zero. It is comparing the result with the expectation already reflected in the price.
If the outcome is close to what was anticipated, the reaction may be limited even if the headline looks significant. A bigger move is more likely when the result catches investors off guard and changes their expectations.
People naturally want to classify economic news as good or bad. Markets are rarely that simple. A result can appear positive and still disappoint if expectations were higher. The reverse can happen when a weak number turns out less negative than investors expected.
We see this with the rand around SARB meetings. If investors are already expecting the Bank to leave rates unchanged, the decision may have little effect on the currency. However, a change in the Bank’s inflation outlook could prompt investors to reconsider where South African interest rates are headed.
For me, that gap between expectation and reality often tells us more than the headline itself. Expectations are built from more than a consensus forecast. What has happened in recent data and how the market is already positioned can shape the view going into an announcement, as can the wider mood at the time.
If traders enter an event heavily positioned for one outcome, confirming that view does not necessarily produce another large move in the same direction. Much of the buying or selling may already have happened.
A relatively small surprise in the other direction can then produce a much bigger reaction than the headline might suggest.
This is also where profit-taking comes into the picture. A market can move strongly ahead of an event and then reverse after the expected result arrives because traders who positioned ahead of the event use the announcement to close those positions.
Another part of this is the narrative dominating the market at the time. Sometimes inflation drives almost every conversation. At other times, investors may care more about growth or employment.
That changes the way new information is interpreted. A data point that triggers an aggressive reaction in one environment may matter far less several months later because investors focus on something else.
When I look at a market reaction, I want to know what investors believed before the news and whether the announcement changed that belief. Otherwise, it is easy to draw the wrong conclusion from the headline.
By Francois du Plessis, CEO of CFI Financial Group South Africa
