Markets celebrate falling inflation

On 14 November 2023 US inflation of 3.2% for October was published, lower than expected. Stocks and bonds rose strongly on the idea that rate rises were over. The change of mood was marked after weeks of pessimism over high rates and geopolitical tension.

The reaction illustrates a constant feature of markets: they do not wait for events to happen, but move according to what they anticipate. A better-than-expected figure can trigger rapid rises because it changes expectations about central banks’ next steps, which in turn changes the value assigned to shares and bonds. These movements are a reminder that financial markets discount expectations, and that good news can have a very different effect depending on what was already reflected in prices at the time it became known.

A better-than-expected figure

The key was that the figure was lower than expected: when a number comes in better than forecasts, markets build it into prices at once, and that reaction can be intense.

What moves the price is not the figure itself, but its difference from what was expected. A 3.2% can be bad news if 3% was expected, and good news if 3.4% was expected. That dynamic explains why markets often react strongly to figures that, seen in isolation, look modest. Surprises, positive or negative, are what really move prices in the short term. A figure that confirms what was expected changes almost nothing, whereas one that departs from forecasts triggers an immediate readjustment of expectations.

Stocks and bonds higher

The move was simultaneous in equities and fixed income. Lower expected rates favour both shares, whose value depends on future profits, and bonds, whose price rises when the required yield falls. November 2023 was one of the best months for equities in years.

The speed of that recovery contrasts with the mood that prevailed barely a few weeks earlier, when long-term rates were rising and the outlook seemed gloomy. It is an example of how hard it is to anticipate turns in the market and how changeable general perception can be over a very short period. For those with invested savings, these rises are good news, but it is worth remembering that the starting level also matters: an excellent month after a period of falls may leave the accumulated result at a more modest point than it seems.

The lesson of pessimism

Whoever sold in October’s pessimism missed the recovery: a lesson that recurs. Reacting to short-term swings usually proves costly, because nobody knows in advance when the market will turn.

That is not a recommendation to buy or sell: it is an invitation to have an investment plan matched to each person’s horizon and risk tolerance, and to review it with an adviser, not with the day’s news. A well-thought-out plan makes it possible to stay calm both in moments of fear and in those of euphoria, and avoids decisions that are later regretted. A well-designed plan decides in advance how to react to sharp falls and rises, with simple rules such as reviewing the portfolio on fixed dates or rebalancing when it drifts from what was planned, rather than deciding on the fly. It also helps to separate money needed in the short term from money earmarked for distant goals, because that way market swings affect only the part that can wait, and the rest remains available without depending on the ups and downs.

Decisions taken out of fear or euphoria are rarely the best ones.

This article is general information. It is not legal, tax or investment advice, and it does not take anyone’s particular circumstances into account.