Reaction to Trade News Shows Stock Market Bulls Are Still Firmly in Control

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Yesterday, after what seemed like years of rumors, leaks and anticipation, Donald Trump and Chinese Vice-Premier Liu He signed “phase one” of a trade deal. Even on a day of big news, with impeachment articles being sent from the House to the Senate and earnings season getting going, that was big news. So, how should investors react?

The answer is that they shouldn’t react to the news at all. It was hardly “news” anyway, it was simply a scheduled signing of an agreement reached a while ago, and even that agreement doesn’t address the real problem from an economic perspective. It constitutes progress, for sure, but the existing tariffs on traded good between China and the U.S. are still in place.

Given that, it is hardly surprising that market moves immediately following the ceremony had a “buy the rumor, sell the fact” feel to them.

Figure 1: S&P 500. 1-Day 5-minute Bars, 1/15/2020

Stocks started strong in the morning, then once the deal was signed in the early afternoon, lost all of those early gains. That would have come as no surprise to anybody familiar with market dynamics. Since the deal was announced on December 13 last year, the S&P 500 has risen 17%. Obviously, not all of that was due to the agreement but given how influential trade has been for the last couple of years, it is logical to assume that a good part of it was. After such a big gain in a month, it is only natural that some of those who bought in anticipation would take a profit when the deal was signed. They positioned themselves on the potential signing of an agreement, not its potential results. Yesterday, their catalyst for buying ended.

The tendency of markets to exhibit that “buy the rumor, sell the fact” pattern on major news is why trading headlines is so difficult.

For retail traders and investors, attempting to trade on news is usually a wasted effort. I worked in dealing rooms for nearly twenty years and can tell you that even there, by the time you as a human being have read and processed the headline and reacted, the market will have already moved. Thinking that you can gain an advantage by reacting quickly from home, without the advantages that a dealing room offers, is just naïve. Instead, non-machine traders watch the reaction to news and learn what they can from that.

On that basis, despite the immediate retracement following the signing, yesterday’s price action was yet another bullish sign for this roaring market.

Figure 2: S&P 500 Futures. 2-Day 5-Minute Bars 1/15-16/2020

The technical selloff lasted exactly one hour, then reversed, with a 63% retracement going into the close. That was the trend that continued, with further gains for futures in yesterday’s post market and before the opening this morning.

Quite often in a nervous market, a technical reversal such as we saw yesterday afternoon can spark a significant, much broader selloff. It suggests that the anticipated news was no big deal after all and that can easily spook longer-term investors. There was, however, no sign of that yesterday. Even that relatively small correction was seen as a “buy” signal, suggesting that any move down remains an opportunity rather than a warning.

“Don’t trade the news, trade the reaction” is advice that I frequently give. Yesterday, when the “news” on trade was just confirmation of what has been known for over a month, that advice was particularly relevant. If you took a step back and watched the market for a few hours, there is only one possible conclusion to come to: We may be at record highs and you may worry about valuations, the Middle East, the election, or any of a host of risk factors, but the bull market is alive and well.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.