I am often amazed at how market analysts and journalists quickly apply cause and effect in the markets with little or no evidence. We have commented here in the past how dangerous it is to attach two seemingly unrelated events. A market can only go up, down or move sideways so there are usually numerous causes you can credit or blame for a market move.
Case in point is this morning’s rally in equities; the Dow Jones Industrial Average is up about 200 points as of mid-morning. In fact it was up by more than 100 points on the first five-minute bar of the day, which would suggest overnight news moving the market.
The early wire stories attributed the move to a drop in crude oil. However, crude oil was actually rallying in the pre open hours and at the time equity markets were spiking higher.
While there has been a connection between oil and equities and equities may have been catching up with overnight action the correlation has not been constant as equities fell yesterday despite sharply lower oil prices. There are literally dozens of fundamental factors (as well as technical factors) that can affect price and just because the one you are subscribing to appears to have caused a move doesn’t mean it wasn’t simply a coincidence.
This is important as many investors may predict a move in one market based on fundamental evidence in another and take a position in that second market only to find that correlation doesn’t apply.
When I worked on the floor, I heard on dozens of occasions a customer say something like this: “this market dropped that means this other market should have done this, but it didn’t.”
The customer usually felt something funny was going rather than question his initial assumption. It may have worked for him in the past or he may have just been lucky.
Cause and effect in markets is difficult to project and when you apply dubious correlations, it can come back to hurt you, so be careful of what you listen to.
Tags: Cause and effect, crude oil, Dow Jones
