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

Which generation had it toughest?

Each generation believes its economic challenges were uniquely tough - but what does the data say? A closer look reveals a more nuanced, complex story behind the generational hardship debate. 

Maybe it’s time to consider taxing the family home

Australia could unlock smarter investment and greater equity by reforming housing tax concessions. Rethinking exemptions on the family home could benefit most Australians, especially renters and owners of modest homes.

100 Aussies: seven charts on who earns, pays, and owns

The Labor government is talking up tax reform to lift Australia’s ailing economic growth. Before any changes are made, it’s important to know who pays tax, who owns assets, and how much people have in their super for retirement.

The best way to get rich and retire early

This goes through the different options including shares, property and business ownership and declares a winner, as well as outlining the mindset needed to earn enough to never have to work again.

A perfect storm for housing affordability in Australia

Everyone has a theory as to why housing in Australia is so expensive. There are a lot of different factors at play, from skewed migration patterns to banking trends and housing's status as a national obsession.

Chinese steel - building a Sydney Harbour Bridge every 10 minutes

China's steel production, equivalent to building one Sydney Harbour Bridge every 10 minutes, has driven Australia's economic growth. With China's slowdown, what does this mean for Australia's economy and investments?

Latest Updates

Economy

Why we should follow Canada and cut migration

An explosion in low-skilled migration to Australia has depressed wages, killed productivity, and cut rental vacancy rates to near decades-lows. It’s time both sides of politics addressed the issue.

Investing

Simple maths says the AI investment boom ends badly

This AI cycle feels less like a revolution and more like a rerun. Just like fibre in 2000, shale in 2014, and cannabis in 2019, the technology or product is real but the capital cycle will be brutal. Investors beware.

Property

Australian house price speculators: What were you thinking?

Australian housing’s 50-year boom was driven by falling rates and rising borrowing power — not rent or yield. With those drivers exhausted, future returns must reconcile with economic fundamentals. Are we ready?

Shares

ASX reporting season: Room for optimism

Despite mixed ASX results, the market has shown surprising resilience. With rate cuts ahead and economic conditions improving, investors should look beyond short-term noise and position for a potential cyclical upswing.

Property

A Bunnings play without the hefty price tag

BWT Trust has moved to bring management in house. Meanwhile, many of the properties it leases to Bunnings have been repriced to materially higher rents. This has removed two of the key 'snags' holding back the stock.

Investment strategies

Replacing bank hybrids with something similar

With APRA phasing out bank hybrids from 2027, investors must reassess these complex instruments. A synthetic hybrid strategy may offer similar returns but with greater control and clearer understanding of risks.

Shares

Nvidia's CEO is selling. Here's why Aussie investors should care

The magnitude of founder Jensen Huang’s selldown may seem small, but the signal is hard to ignore. When the person with the clearest insight into the company’s future starts cashing out, it’s worth asking why.

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.