The Orwell piece that I mentioned yesterday chimed with something that I was thinking about that morning: the relationship between news, reality and markets. Here is a first attempt to set out what I think about the relationship, with examples.

  1. Reality can move markets. QE creates money that flows into equities, driving up prices.
  2. Markets can focus on varying aspects of reality. Today they are focussing on the improving US consumer picture and not on unemployment.
  3. The market focus can drive the news. Sugar prices rise because traders hear about poor planting conditions in Brazil; poor planting conditions in Brazil are reported.
  4. News also focuses on varying aspects of reality. The headlines report a successful European agreement, even though it does nothing to address current problems.
  5. The news focus can drive the markets. Reports of Chinese buying of Portuguese debt drive up the euro.
  6. Markets can alter reality. Higher equity prices have a wealth effect.
  7. News can alter reality. Reports of job losses hurt consumer confidence.
An important part of trading is understanding which of these relationships is important at the present time. For risk assets, I think the most important thing at the moment is reality driving markets: QE drives up asset prices. News will affect markets in the short term, driving them down when it is bad, but the pressure will remain upward. For the euro, I think reality driving news and news driving markets are the important things: the reality is that Europe is in a big mess, and that reality will periodically break into the news and drive down the euro.
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