Surprise!
That is one powerful word that will shake a short-term trader to their core.
You see, traders are a pretty confident bunch. They have done all of the analysis, calculated the upside opportunities and downside risks, and positioned themselves for what they believe will be a near-term trading profit based on what they think they know about the future.
And when the future is not what they expect, traders sell first and ask questions later.
You have likely noticed a significant uptick in market volatility over the past week courtesy of two significant economic surprises that a large majority of traders did not see coming.
Surprise No. 1: Bank of Japan
The U.S. Federal Reserve has been very communicative with traders to properly set expectations for the timing of their next interest rate change. Granted, traders sometimes inaccurately extrapolate what the Federal Reserve is saying; however, there is usually a strong consensus leading up to a Federal Reserve Open Market Committee meeting on the likely outcome.
The Bank of Japan failed in setting proper expectations leading up to their meeting last week. Only a small minority of traders expected them to raise their target interest rate, but they did. Additionally, the Bank of Japan indicated that additional interest rate hikes were likely in the future.
Over the last several years, Japan has maintained very low interest rates relative to the rest of the world as they have greeted inflation as a sign of economic growth after years of stagnation. This allowed traders to borrow money in Japan at a very low cost and invest it in other countries with higher interest rates or more growth as a “low-risk” opportunity for trading profits.
The Bank of Japan’s surprise rate increase and inclination to raise rates further flips traders’ “low-risk” strategy for profits on its end. Suddenly, traders find the need to sell the investments they bought with borrowed funds and pay down their Japanese loans – creating self-reinforcing selling pressure. Unwinding this trading strategy could create additional downside pressure on asset prices in the near-term.
Surprise No. 2: Jobs report
Last Friday’s jobs report missed expectations by a wide margin. Job creation was anemic and the unemployment rate ticked up to 4.3%.
This surprise immediately led traders to the conclusion that the U.S. economy was rapidly cooling, and a recession may be afoot in the near future.
Except when you look beyond the horrific headlines of Friday’s job report, you find interesting tidbits that make one question the validity of those headlines. For example, an unusually large number of individuals (461,000) were temporarily unemployed due to weather (perhaps a hurricane created massive power outages in Texas?).
Additionally, of the 314,000 newly unemployed last month, a large majority (79%) were considered temporarily unemployed. Typically, this is a result of auto manufacturers switching their production lines for the new model year around this time of year.
Thus, if the weather changes and the temporarily unemployed return to work within the next month, we have the potential to see hundreds of thousands of jobs “created” over the next month because people simply returned to their jobs. We will see!
As long-term investors, we find the constant emotional scrambling of short-term traders rather exhausting. We understand those traders set the immediate market price for investment assets and, therefore, completely control our daily account values. We also understand they tend to overreact both to negative and positive surprises.
Thankfully, we also have the perspective that today is just another day in the journey to our long-term goals and the fears that are influencing traders today will cycle back to greed at some unexpected point in the future.
Quote of the week:
Napoleon: “A genius is the man who can do the average thing when everyone else around him is losing his mind.”
