The Importance of Context: A Crystal Ball Isn't Always Enough
On September 18, 2024, the Federal Reserve (Fed) reduced the Fed Funds rate by 50 basis points. This move was expected to be beneficial for bond traders. However, contrary to expectations, bond yields increased after the rate cut. This unexpected outcome highlighted the importance of context in trading and investment decisions.
The rise in bond yields, despite the rate cut, puzzled many investors. Various theories were proposed, including the Fed's potential role in stoking inflation or the impact of China's massive stimulus package. However, the real reason for this development was much simpler - it was all about context.
The rate cut did not occur in a vacuum. Investors had been anticipating a rate cut at the September meeting for several months. In the days leading up to the announcement, the odds of a 50bps rate cut had significantly increased. The key context was the 1% decline in ten-year note yields since April, and the fact that bond prices were extremely overbought on a technical basis.
The Importance of Technical Analysis
On the day the Fed cut interest rates, ten-year note yields rose slightly from an opening yield of 3.68% to close the day at 3.69%. Five days later, the yield rose another .12% to 3.81%. A trader with a crystal ball predicting the rate cut would have suffered losses. However, a trader who considered the context of the market conditions and recent trends could have been more successful. This context can often be obtained from technical analysis.
The Crystal Ball Challenge
An article titled "When A Crystal Ball Isn’t Enough To Make You Rich" by Victor Haghani and James White, along with their Crystal Ball Challenge, provides valuable insights into the importance of context. The challenge involved giving over 118 young adults schooled in finance a crystal ball with tomorrow’s headlines and observing their ability to predict short-term price changes.
The results were surprising. The finance professionals posted a meager positive return, not significantly different from flipping a coin. The authors attributed the poor results to two factors. First, the participants did not correctly guess how stocks and bonds would perform with knowledge of the headlines 36 hours in advance. Second, they did not size their bets properly.
Experience and Context Matter
The authors then invited five experienced macro traders to take their test. These traders correctly predicted the impact of the headlines 63% of the time and posted an average return of 130%. The experienced traders were selective in their trade-sizing and did not bet on about one-third of the trading opportunities. They bet big on days when they felt confident about the impact of the news on stock or bond prices.
This study underscores the importance of context in investing. Technical analysis can provide significant context regarding recent trends, the strength of these trends, and potential changes in momentum. Additionally, understanding the liquidity situation of a market and the Fed's current stance on monetary policy is crucial.
Bottom Line
While a crystal ball could be a valuable tool for market analysis, it is not sufficient on its own. Advanced knowledge of market, economic, and political conditions can positively impact performance over the long run. However, trading on a short-term basis without context can be detrimental.
Furthermore, assumptions about specific outcomes due to particular news are often incorrect. As the old saying goes, "buy the rumor, sell the news!" What are your thoughts on this article? Share it with your friends and sign up for the Daily Briefing, which is delivered every day at 6 pm.
The Importance of Context: A Crystal Ball Isn't Always Enough
On September 18, 2024, the Federal Reserve (Fed) reduced the Fed Funds rate by 50 basis points. This move was expected to be beneficial for bond traders. However, contrary to expectations, bond yields increased after the rate cut. This unexpected outcome highlighted the importance of context in trading and investment decisions.
The rise in bond yields, despite the rate cut, puzzled many investors. Various theories were proposed, including the Fed's potential role in stoking inflation or the impact of China's massive stimulus package. However, the real reason for this development was much simpler - it was all about context.
The rate cut did not occur in a vacuum. Investors had been anticipating a rate cut at the September meeting for several months. In the days leading up to the announcement, the odds of a 50bps rate cut had significantly increased. The key context was the 1% decline in ten-year note yields since April, and the fact that bond prices were extremely overbought on a technical basis.
The Importance of Technical Analysis
On the day the Fed cut interest rates, ten-year note yields rose slightly from an opening yield of 3.68% to close the day at 3.69%. Five days later, the yield rose another .12% to 3.81%. A trader with a crystal ball predicting the rate cut would have suffered losses. However, a trader who considered the context of the market conditions and recent trends could have been more successful. This context can often be obtained from technical analysis.
The Crystal Ball Challenge
An article titled "When A Crystal Ball Isn’t Enough To Make You Rich" by Victor Haghani and James White, along with their Crystal Ball Challenge, provides valuable insights into the importance of context. The challenge involved giving over 118 young adults schooled in finance a crystal ball with tomorrow’s headlines and observing their ability to predict short-term price changes.
The results were surprising. The finance professionals posted a meager positive return, not significantly different from flipping a coin. The authors attributed the poor results to two factors. First, the participants did not correctly guess how stocks and bonds would perform with knowledge of the headlines 36 hours in advance. Second, they did not size their bets properly.
Experience and Context Matter
The authors then invited five experienced macro traders to take their test. These traders correctly predicted the impact of the headlines 63% of the time and posted an average return of 130%. The experienced traders were selective in their trade-sizing and did not bet on about one-third of the trading opportunities. They bet big on days when they felt confident about the impact of the news on stock or bond prices.
This study underscores the importance of context in investing. Technical analysis can provide significant context regarding recent trends, the strength of these trends, and potential changes in momentum. Additionally, understanding the liquidity situation of a market and the Fed's current stance on monetary policy is crucial.
Bottom Line
While a crystal ball could be a valuable tool for market analysis, it is not sufficient on its own. Advanced knowledge of market, economic, and political conditions can positively impact performance over the long run. However, trading on a short-term basis without context can be detrimental.
Furthermore, assumptions about specific outcomes due to particular news are often incorrect. As the old saying goes, "buy the rumor, sell the news!" What are your thoughts on this article? Share it with your friends and sign up for the Daily Briefing, which is delivered every day at 6 pm.
