Is economic data relevant to markets?

Thu, 31 Jul Pre-Open

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Stock markets are quite fickle when it comes to digesting news. At times they can overreact to the smallest positive or negative event. On the other hand, there are times when markets shrug off a significant event without much of a price movement. This moody nature of the markets is well known. Short term traders are particularly concerned about price swings. However, long term investors do not pay too much attention to short term market moves as they do to the news itself.

In this context, let us examine the impact that economic data has on the markets. On the face of it, economic data is important. Data relating to interest rate movements, GDP, current account deficit/fiscal deficit, inflation, IIP etc are all important economic indicators. They help us to track the health of the economy. Thus one would think that stock markets would keenly await the release of this data and react accordingly. However, this is not entirely true. While market participants do try to predict/anticipate economic data, markets in general, do not react too much upon its release.

Why is this so? Are the markets disconnected with economic reality? The answer is not so simple.

There are various types of investors in stock markets. An intra-day trader will show little concern for such data except on the day when it is released. Long term investors, on the other hand, do keep a sharp eye on such data but they do not react to it in the same way. Macro investors who follow a top-down investing approach might change their portfolio allocation towards certain sectors. For example, if they believe that the inflation is on the rise then they might reduce their exposure to interest rate sensitive sectors like real estate, fearing rate hikes by the RBI. At the same time, bottom up stock pickers would be more concerned about the effect of the higher interest rates on their individual stock picks. Thus, two long term investors in the same stock can react differently to the same set of economic data. The cumulative reaction (to important economic data) of all market participants, results in muted price movements on many occasions.

Does this mean that economic data is irrelevant to the markets?

Certainly not! In the long run, macro economics does play its role in influencing stock prices. Investors should not ignore it. The trends in economic data should be of particular interest, as they can point investors in the right direction regarding the big picture. However, it is important to not go overboard while analyzing such data. We believe investors will be best served by the bottom-up investing approach. In the long run, if the fundamentals of an individual business remain intact then irrespective of the economic conditions, the stock will reward long term investors.

Does economic data impact your investment approach? Do let us know your view in the Equitymaster Club.