Sell the fact

“Buy the rumor, sell the fact” is one of the best-known market adages. Act on the expectation, the assumption, the possibility. Then, when whatever it is you expected to happen actually materializes and the thundering herd of investors jumps on the bandwagon – that’s the time to get off. This is impeccable market logic, it works in both directions – i.e. for both positive and negative expectations/ rumors and facts, and if followed consistently, it generates good results.

The reason most people don’t apply this maxim and act by it is because, despite all the foregoing advantages, it requires exceptional courage and determination to actually do it. That is somewhat true for stage one, which is buying on the rumor, but there at least you can be buoyed by your conviction that you are doing the right thing and, hey, you’re smarter than the rest of the pack. But selling on the fact – that’s very difficult. The share, or the market, or whatever it is you bought is now delivering the goods. It’s steaming ahead, and you are raking in profits. Everyone else – the dummies who were not smart like you – is piling in. To sell out now, to go against the crowd, that’s really difficult.

Given these general remarks, what is one to make of the activity across the financial markets over the last several days, especially Wednesday and Thursday of this week, when they sold off heavily? In the US, the news has been mixed, but leaning in the positive direction: many of the big companies announcing their 2009 results in recent days have ‘exceeded analysts’ expectations’ (this is meaningless drivel, but that’s what the headlines blare, so people are influenced by it). Yet the US equity markets have suffered their heaviest two-day sell-off in months and are looking ripe for further declines.

Over in China, data published this week show the economy back on the path of rapid growth, with the slump of late 2008-early 2009 fading into memory. Yet the Chinese stock market has dropped, whilst the market in Hong Kong – most people’s entry point into Chinese equities – has fallen by some eight percent over the last week or so.

The most obvious explanation would be that people are selling the fact – of positive results at either the corporate or macro levels – and taking profits, after having earlier bought the expectations and predictions of these items of good news. But even if this explains the sudden reversal from strength to weakness in equity markets, it does not explain the much more dramatic falls in the prices of precious and base metals, nor the rapid rise of the dollar against most other major currencies – except, significantly, the yen.

It may well be, therefore, that people are selling a different fact – not good news, but bad news. The official bad news came from China, in the form of indications and then actions that showed that the Chinese government is now alarmed by the success of its own expansionary policies and stimulus programs. It was these that generated the rapid return to rapid growth during 2009 – but the game of throwing money at banks and ordering them to lend it to whomever they could find has gotten out of hand. In the first two weeks of January, Chinese banks lent out sme 1-1.5 trillion yuan (about $150-200bn worth) and this seems to have triggered a clampdown.

In China, clampdown means clampdown. They don’t use nods and winks, like the British, nor do they rely on open market operations like the Americans. The regulator called in some top bankers and told them to stop lending, period. That is a fact worth selling, because it was the massive Chinese stimulus last year – by far the biggest, relative to the size of the economy – that fuelled the building boom and house price inflation in China. That money, together with the huge funds made available by the central banks of developed countries, has caused equity prices to soar around the world and has driven the prices of most commodities to huge gains during 2009.

The Chinese central bank is now reversing course. Others are likely to follow – the Federal Reserve is already winding down its emergency liquidity programs. The removal of liquidity may have as great an impact as its introduction, or even worse. Smart people are not waiting around to find out

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