There is a difference between “bad” data and “wrong” data. Look at the markets in 2009, 2010, and 2011. Then look at the data.
While much has been made about how 2010 and 2011 look similar little has been said about how similar 2009 was to those other years. All three years had big directional moves in the first quarter, followed by big reversals starting in the second quarter. If you think about it that way, 2009 was the same as 2010 and 2011.
Why would this be the case?
I do think hedge fund trading patterns and bank trading patterns encourage this activity. As hedge funds have become more focused on how much they can make from the 2% they are far more conservative in their investments. They shut down towards year-end and ramp up again in the first quarter. At one point hedge funds were driven by the 20% and this phenomena wasn’t as common, but with poor returns, the 2% and gathering AUM has replaced the focus on returns.
As recently as 2008, banks and investment banks tended to have staggered year-ends. There are no investment banks, so everyone has the same year-end now. I think this too may play a part in what we are seeing. The timing that this is occurring post 2008 seems a bit too coincidental to completely ignore.
But the real reason may be that we just get “wrong” data. The adjustments are a total mess and don’t reflect what is going on in the market. So January data now comes in much better than expected (and reality) and stocks go up. Then February data also comes in much higher than expected and while having nothing to do with the reality of the economy, also forces stock prices up.
Then we start missing on data. Not because the economy has changed, but because the data is equally messed up coming back down. The data isn’t reflecting the economy it is reflecting adjustments and estimates. So we get this pattern of stocks reversing because that’s what the data is telling the market, but the data is garbage.
The economy was never as good as the data said it was. Stocks should never have gotten to 1,400 based on the economy. If we had “good” data, as in accurate data, the market wouldn’t have gotten that high. So in the past few years, we have reversed course with the data.
But what will happen this year?
Finally, everyone seems to be pointing out how inaccurate our data is. How little it reflects the economy. My question or concern is whether this realization will support stocks here. Whether investors will ignore the data because it is inaccurate? In theory that realization should send stocks immediately down, but in practice prices might be sticky. The market might be able to ignore the fact that stocks are only so high, in part because of rallies on inaccurate data, and decide to ignore bad data as being inaccurate now. It’s not logical, but anyone still clinging to the belief that the market is purely logical is more naïve than me.
Lots to think about, but with 2012 starting to look a lot like prior years, these topics are likely to be at the forefront of market chatter and determining how they play out will be key.
My gut feel is that somehow the market will convince itself to ignore inaccurate data and not correct for reaction to prior inaccurate data. Then we have a bit more time for all those funds and banks that thought this would be like 2010 and 2011 to load up on risk and then we can have a good old fashioned 2007 summer.