Making noise but going nowhere
3 DECEMBER 2011
- By Asad Dossani, Author, The Lucrative Derivative Report
In the last three months, the markets have been extremely active. Every week something interesting is happening in the global economy that causes the markets to move large amounts in a short space of time. This week, markets shot up due to coordinated global central bank action to increase dollar liquidity. In the previous weeks, markets were crashing due to fears of a destabilizing Eurozone default.
Over the course of the last three months, a lot has changed in the global economy. What about the stock market? The stock market tends to respond quickly to global economic events, and recently has seen large up and down movements. This is no surprise given the news we read everyday.
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However, if we look at the total stock market movement over the last three months, we find something quite surprising. On 2nd September 2011, the BSE-Sensex closed at 16,821. On 2nd December 2011, it closed at 16,845. This is a movement of 0.1%, tiny in comparison to movements on a daily basis. Essentially, the stock market has made a lot of noise in the last three months, but has gone nowhere.
Over the course of the last three months, most of us would have probably become more pessimistic about future market prospects. Most of the news in the financial press over this time has been negative. And yet, despite primarily negative news, the total stock market movement over this time has been almost nothing.
While the overall stock market may not have changed, one thing about the market has changed in the last three months. I'm talking about the volatility of the stock market. Stock market volatility has increased dramatically in the last three months. On a daily basis, it is not uncommon to see movements of 1%, 2% or even greater.
So how should we interpret the current market situation? What we have is extremely high volatility with no directional trend. The fact that there is no overall direction probably means that the market is cautiously optimistic. If the market were pessimistic, we'd have seen a large fall. If the market were optimistic, we'd have seen a large rise. If the market were optimistic, but still unsure of what would happen, we get no directional trend. This is where we are now.
The excess volatility means that the market is extremely sensitive to news events. It implies that a lot of movement is based on sentiment factors rather than real fundamentals. Bouts of optimism and pessimism are driving the stock market, rather than news about earnings or other fundamental factors.
This can often be painful for those holding a stock portfolio, as values may change quickly with little or no fundamental basis behind it. However, it also presents a good opportunity to find mispriced stocks. Its highly likely that over the course of the last three months, many individual stocks have moved significantly, yet their fundamentals have seen little or no change.
Though the market has been making noise but going nowhere, it is probably likely to start trending in a particular direction sometime soon. At some point, this debt crisis will start to play itself out and a lot of uncertainty will get resolved. As this occurs, volatility should fall and the market will slowly return to normal.
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