Schaeffer's Trading Floor Blog

Did Russia Really Cause the Recent Sell-Off?

The issue of simplifying the relationship between headlines and market behavior

by 3/19/2014 7:12 AM
Stocks quoted in this article:

I guess now we know for sure that volatility got pumped up on worries that Russia would annex Crimea.

Well, the masses got that one right. Russia did file their paperwork (maybe they can call in Icahn as a White Knight).

But, a funny thing happened. Realized volatility did nudge up, but not exactly for the reasons that most expected. It went up thanks to two reasonably strong market rallies. And, the CBOE Volatility Index (VIX) gave back all of its gigantic gains from Friday.

There's a lesson here that gets hammered at home again and again.

Financial media likes to simplify the relationship between news and market action. It causes a false sense of causation. The market got clocked recently on a Monday, ostensibly on news that Russia had invaded Ukraine.

Russia really did invade Ukraine, and the market really did get clocked, so it was natural to connect the two events and say the invasion caused the sell-off. And, perhaps it did to some extent. But, perhaps it was simply due for a sell-off that day or soon after for a variety of reasons. The invasion was maybe the catalyst for a market move that was going to happen anyway. It's de facto setting off a spark in a dry forest. The conditions were there for a fire already, the spark simply ignited it.

But, on a different day, very similar news caused a diametrically opposite reaction. We faced another weekend of worries about what Russia would do, we basically got the worst fears, and … this time the market rallied strongly. The news gets even "worse" overnight Monday, and we rally some more.

The difference is that the backdrop beyond Ukraine has changed. It was a bit of a surprise a few weeks ago, now it's basically discounted -- at least this level of hostility. And, it was always debatable how developments there would affect corporate earnings here, anyway.

This is why it's always good to avoid false causality. The same news never affects the market in the exact same way. There are simply too many other variables -- it's very rare that one event alone drives the market the same way more than once.

I understand why media does what they do. It's easier to simplify relationships than to add layers of complexity. It's only dangerous if you pay too much attention to it, and think you can predict a market reaction. Many a time, you could have known the exact news in advance and gotten the direction of the move completely wrong.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.

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