Fiscal Cliff Rally? Beware the News You Don’t See

Thursday, 03 Jan 2013 07:37 AM

By Patrick Watson

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“Financial markets shot higher today following the passage of a fiscal cliff solution by Congress.” Whatever your news source, you probably saw a sentence much like this on Jan. 2. The story practically wrote itself. But was it true? Think for a minute.

The facts are indeed correct. The House and Senate did agree, on New Year’s Day, to a compromise bill resolving some (not all) of the potential fiscal cliff problems. Stock markets did, in fact, rise sharply the next day. The media isn’t lying to you. Readers, however, don’t necessarily draw the right conclusions.

Suppose event A occurs. The next day, event B occurs. Can we therefore assume that event A caused event B? Not necessarily. Maybe B would have happened anyway. Maybe A contributed to B, but only because of some unknown event C. As statisticians say, “Correlation does not equal causation.”

Investors make this mistake all the time. Something happened this morning. Stocks went up or down. Journalists do their duty and report the facts. Readers, eager to assign credit or blame, subconsciously insert “because” between the two facts. This is a dangerous habit, one all investors would be well-advised to break.

Markets go up. Markets go down. Markets go sideways. Sometimes the reason is obvious. Most of the time, it is more complicated than event A causing market reaction B. Jan. 2, for instance, was not simply the day after the fiscal cliff deal. It was also the first day of trading in 2013. Portfolio managers who engaged in year-end “window dressing” needed to get re-invested quickly. Their frantic buying was a factor, too.

Was portfolio dressing more or less important than what happened in Washington the day before? I don’t know. No one else does either. Most likely the day’s result included both factors, along with others we don’t even recognize.

Stock market math is rarely as simple as A+B=C. Don’t let the media trick you into thinking otherwise. The news you don’t see may be more important than the headlines.

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