Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 40

A day in the life of theory versus practice

Thursday 7 November 2013 was a good example of the often perverse relationship between economic growth, company earnings and share prices, and also an example of how markets react to unexpected news in unexpected ways.

In theory, improving prospects for economic growth and company earnings should be good for share prices, while deteriorating prospects should be bad. Nice theory, but not in the real world, whether we are talking about daily, monthly, quarterly or even yearly time periods.

Expected versus unexpected

In the case of the relationship between news and share prices, expected news - like expected profits, dividends, economic numbers or interest rate changes, etc - is generally already factored into prices every day so it is unexpected news that causes prices to jump up or down sharply.

For example, if the market consensus is expecting a particular company to announce a 20% profit rise next Tuesday and it does in fact announce the 20% profit rise, then the share price will not jump up on Tuesday. But if for some reason the company announces flat profits on Tuesday the share price will most likely fall significantly (all else being equal) even though profits have not fallen.

Thursday 7 November 2013 was a good example of these factors at work in real life. There were two significant pieces of unexpected news that affected global markets.

European Central Bank rate cuts

The European Central Bank unexpectedly cut the refinance rate by 0.25% to 0.25%, and the emergency bank borrowing rate was cut by 0.25% to 0.75%. European Central Bank President Mario Draghi also said that the ECB still maintained an easing bias, meaning more rate cuts were possible.

This was a big deal as it represented a change in policy stance and a change in the dynamics of the tussle between the hard line pro-austerity ‘north’ led by the Germans and the pro-growth, anti-austerity ‘PIIGS’ led by France and the International Monetary Fund.

Following the convincing win by Angela Merkel’s Christian Democrats in the German Bundestag elections in September, the feeling in markets had been that the Germans would be highly likely to continue with their bias toward a moderately hard-line stance on austerity and fiscal rectitude, which is deflationary and stifles growth at least in the short  term.

Inflation and growth numbers out of Europe over the past several weeks have being pointing to a slowing in the anemic European recovery. There was even talk about a rising risk of deflation, which is almost universally agreed to be even more devastating to economies and company earnings than than inflation.

European markets were trading flat in the morning until the announcement of the ECB rate cut. The moment the ECB announced that European growth was so sick the ECB has had to apply even more medicine to the ailing patent on life support, and that possible deflation was on the cards, investors all across Europe rejoiced and raced in to buy more shares at higher prices!

US economic growth

Then the second big piece of unexpected news hit the airwaves. The third quarter US economic growth number was better than expected and so perhaps the US would emerge from intensive care sooner than the market had previously expected.

Better than expected recovery for the US economy is good news for the prospects for company earnings and dividends and so should be good news for share prices - in theory.

But in practice such news was seen as bad news and investors across Europe, and in the US when markets opened there, dumped shares on the bad news that the economy and company earnings prospects were now improving.

The first chart from The Financial Times shows European markets during 7 November 2013. The second chart shows American markets opening after the ECB announcement, selling off across the board on the 'good news' of a stronger US recovery. Not even the successful Twitter listing was enough to lift markets.

Addiction to cheap money

The missing link is cheap money. Share prices are moved by the weight of investors’ money and most investors have become addicted to rivers of cheap money for the past five years. They are motivated more by the prospect of more cheap debt flooding the world than by the reason for the need for the cheap debt in the first place.

The US and European economies have been on life support in intensive care since the start of QE1 following the Lehman bankruptcy in September 2008. The weak economic recoveries and the stock market recoveries that began in early March 2009, and property markets more recently, were made possible, and supported, by an unprecedented flood of cheap money artificially created on a global scale by the major central banks of the world.

Markets work in mysterious ways, and not much of it has to do with text book theory.

That’s just one day - what about longer periods?

The above story relates to how markets worked on a particular day. Similar perverse relationships operate on much longer timescales, including monthly, quarterly and even yearly. For a fuller explanation, see this article on economic growth and market cycles.

For example, in 2012 global economic growth was below average, and earnings and dividends were flat or falling, but global stock market returns were above average. This followed 2011 when global economic growth was above average and earnings and dividends rose, but stock market returns were poor and well below average.

Going back further, in 2009 world economic growth contracted in the deepest global recession since the 1930s depression, but shares had a great year in 2009 and the world stock market index was up by 29%!

It pays to focus on what drives markets in the real world and not follow simplistic text book theories.

 

Ashley Owen is Joint Chief Executive Officer of Philo Capital Advisers and a director and adviser to Third Link Growth Fund.

 


 

Leave a Comment:

RELATED ARTICLES

The ASX's 16-year drought: a rebuttal

Even Warren Buffett lost his edge 20 years ago

The BIG picture: portfolios perform for the passive and patient

banner

Most viewed in recent weeks

16 ASX stocks to buy and hold forever, updated

This time last year, I highlighted 16 ASX stocks that investors could own indefinitely. One year on, I look at whether there should be any changes to the list of stocks as well as which companies are worth buying now. 

2025-26 super thresholds – key changes and implications

The ABS recently released figures which are used to determine key superannuation rates and thresholds that will apply from 1 July 2025. This outlines the rates and thresholds that are changing and those that aren’t.  

Is Gen X ready for retirement?

With the arrival of the new year, the first members of ‘Generation X’ turned 60, marking the start of the MTV generation’s collective journey towards retirement. Are Gen Xers and our retirement system ready for the transition?

Why the $5.4 trillion wealth transfer is a generational tragedy

The intergenerational wealth transfer, largely driven by a housing boom, exacerbates economic inequality, stifles productivity, and impedes social mobility. Solutions lie in addressing the housing problem, not taxing wealth.

What Warren Buffett isn’t saying speaks volumes

Warren Buffett's annual shareholder letter has been fixture for avid investors for decades. In his latest letter, Buffett is reticent on many key topics, but his actions rather than words are sending clear signals to investors.

The 2025 Australian Federal election – implications for investors

With an election due by 17 May, we are effectively in campaign mode with the Government announcing numerous spending promises since January and the Coalition often matching them. Here's what the election means for investors.

Latest Updates

World's largest asset manager wants to revolutionise your portfolio

Larry Fink is one of the smartest people in the finance industry. In his latest shareholder letter, the Blackrock CEO outlines his quest to become the biggest player in private assets and upend investor portfolios.

Economy

Australia's economic report card heading into the polls

Our economy grew by a nominal rate of 7% per annum from 2017 to 2024, but it benefited from the largesse of fiscal and monetary policies, both of which are now fading. We need a new, credible economic growth agenda.

Preference votes matter

If the recent polls are anything to go by, we are headed for a hung parliament at the upcoming federal election. So more than ever, Australians need to give serious consideration to their preference votes.

SMSF strategies

Meg on SMSFs: Tips for the last member standing

It’s common for people as they age to seek more help in running their SMSF if their capacity declines. An alternate director may be a great solution for someone just planning for short-term help in the meantime.

Wilson Asset Management on markets and its new income fund

In this interview, Matthew Haupt from Wilson Asset Management discusses his outloook for the ASX, sectors such as REITs that he likes, and his firm's launch of a new income-oriented listed investment company.  

Planning

‘Life expectancy’ – and why I don’t like the expression

Life expectancy isn't just a number - it's a concept that changes with survival rates over time. This article breaks down how age, survival, and societal factors shape our understanding of life expectancy, especially post-Covid. 

The shine is back on gold, and gold miners

Gold mining stocks outperformed in 2024 and are expected to do well in 2025. At this point in the rally, it's worth considering what has driven gold prices higher and why miners could still have some catching up to do.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.