A Costly Misnomer

“That’s completely irrational!”

I overheard that statement yesterday, in reference to the fact that major stock indices closed higher on Tuesday, following Day 1 of the U.S. Government shutdown.

It was simply an utterance, not an invitation for intellectual debate, so I let it slide. But I couldn’t stop thinking about it…

For one, rationality itself is neither pure science nor a provider of standard, cut-and-dry answers. And while many theories of how markets work rely on the “rational actor” theory, behavioral finance studies have repeatedly shown investors’ decision-making abilities are riddled with cognitive biases that often lead them to make, what some would call, irrational decisions.

So I question the value in subjectively labeling market moves as rational or irrational. Traders don’t care what market participants should, in theory, be doing… we only care about what prices are doing.

Second, it’s a gross oversimplification – and a perpetually costly mistake – to assume the market’s moves from day to day are dictated or influenced by just one variable.

Is the government shutdown being factored into investors’ decisions? Absolutely!

But is it the ONLY factor? Absolutely not!

Instead of opining on the rationality of investors’ buying and selling habits, on Tuesday, Guggenheim Partners’ Scott Minerd shared historical analysis on the 17 U.S. government shutdowns we’ve seen since 1976.

I say let this be our guide for navigating the global financial markets, sans U.S. government, instead of our own impressions, opinions or guesstimates of what a shutdown should mean.

So here’s the chart: five asset classes and their performance during and after U.S. government shutdowns:

See larger image

As you can see, stocks and the U.S. dollar tend to fall during a shutdown, then surge higher – between 1.2% and 1.7% – over the 10 days following the shutdown’s end.

Meanwhile, gold and commodities do the opposite, tending to rise during the shutdown, only to drop again once the shutdown is resolved.

If you put these historical, event-driven tendencies into context with our views here at Dent Research, you can view the government shutdown as a potential re-entry opportunity.

We’ve been recommending long-stock and long-U.S. dollar positions for two years. Underperformance during the shutdown could be a dip worth exploiting, with an expectation of positive gains once the government gets back to work.

Likewise, we’ve been bearish on gold and commodities for two years – so any price increases prompted by the shutdown would give you favorable entry points for bearish positions, which should perform well once the shutdown ends.

Choosing to ignore this keenly constructed statistical study – put forth by the Chief Investment Officer of a global financial services firm with $180 billion in assets under management (Guggenheim Partners) – well… that’s the only decision I’d call irrational.

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Categories: Markets

About Author

Adam O'Dell has one purpose in mind: to find and bring to subscribers investment opportunities that return the maximum profit with the minimum risk. Adam has worked as a Prop Trader for a spot Forex firm. While there, he learned the fundamentals of trading in the world’s largest market. He excelled at trading the volatile currency markets by seeking out low-risk entry points for trades with high profit potential. An MBA graduate and Affiliate Member of the Market Technicians Association, Adam is a lifelong student of the markets. He is editor of our hugely successful trading service, Cycle 9 Alert.