Asymmetrical trading sees markets reacting positively even to bad news

TORONTO, Feb. 28, 2012 /CNW/ - Global markets are looking for signs that conditions are improving and any sliver of good news, no matter how small, is driving gains in the market, finds a new report from CIBC World Markets Inc.

"These are not normal times," says Benjamin Tal, Deputy Chief Economist at CIBC. "In normal times investors overreact to bad news more than they react to good news. In today's environment, good news has the upper hand. Investors are highly responsive to positive data surprises, while negative news is often ignored or creatively interpreted as good news."

"Greece-fatigue makes European developments secondary in affecting the mood in the market with investors growing increasingly indifferent to news from the zone - probably with the realization that any turn to the worse will be dealt with effectively by the European Central Bank."

Despite the negative surprises that dominated the news during the past three months, the Canadian market has managed to grow by nine per cent, notes Mr. Tal. He says investors seemingly ignored Canadian data and paid more attention to positive factors in the U.S. and international economies.

In the U.S., the 12 per cent rally in the S&P 500 since mid-December is largely attributed to the better-than-expected economic data during that period. But, on average, the market has also reacted positively to negative data surprises. "This asymmetrical trading is due largely to the current asymmetrical Fed policy," adds Mr. Tal.

"No less than one-third of all major economic data released over the past three months outpaced expectations. And those positive surprises were immediately translated into gains in the equity market. After all, with the Fed committed to remain in neutral until 2014, the market can enjoy the full benefit of stronger-than-expected macro data without worrying about the usual spoiler of increased policy-tightening expectations.

"More interesting, however, is the average 0.13 per cent daily market gain in the S&P 500 in reaction to the 20 per cent of releases that have fallen short of expectations. The logic here is that any sign of economic weakness increases the likelihood of a third round of quantitative easing, with clear positive implications for the market."

Mr. Tal expects Canadian investors will continue to focus on U.S. economic data and largely ignore further negative news from Canada's manufacturing sector where the drag of the strong dollar is still clearly evident.

In a section of the report authored by Avery Shenfeld, Chief Economist at CIBC, and Warren Lovely, Senior Economist at the bank, the struggles of a sector seriously impaired by a strong Canadian dollar are highlighted. Manufacturing's share of Canada's GDP has plummeted since the Canadian dollar turned the corner, but it has also lost ground on a relative basis versus the U.S., where the factory sector's footprint has held steady.

Manufacturing now contributes just over 12 per cent of Canada's Real GDP compared to nearly 19 per cent at the turn of the millennium. While, factory output in Canada has seen a revival from the depths of the 2008 recession, much of that has been delivered from a one-time recovery from cyclically depressed demand.

Mr. Tal expects that as economic, fiscal and political power consolidates in western Canada, regional income inequity will soar. While Canada's monetary authorities can avoid accelerating that process by keeping rates on hold for longer, it won't prevent a further hollowing out of Canada's manufacturing heartland.

"The likelihood is that investors will have plenty to ignore in the coming months," he adds. "How long this win-win trading environment will last is anybody's guess, but the likelihood is that this process has not been exhausted yet."

"The euphoric trading could continue until the market wakes up to the realization that whatever it gets now will be taken away by the big fiscal drag of 2013."

The complete CIBC World Markets report is available at:
http://research.cibcwm.com/economic_public/download/eifeb12.pdf.

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