The Flinchum File
Thoughtful Economic Analysis and Existential Opinions

Baking a Cake . . . or Baking a Market

10/28/2010

When you look at a cake, you are seeing the end result of whatever ingredients went into it. The same is true when you look at the market. Instead of flour, butter, mix or whatever goes into a cake, information and expectations go into the market.

Most people understand why information moves a market, but expectations about information are just as important. Yesterday’s roller-coaster market is a good example.

Yesterday’s Wall Street Journal reported the quantitative easing by the Fed to be announced next week would be much less that expected and over a longer period of time. The market promptly dropped almost 160 points. That afternoon, legendary Abby Joseph Cohen of Goldman Sachs predicted the Fed would do more than the Journal reported, about $500 billion as earlier expected. As a result, the market rallied over a hundred points, finally closing down only 43 points.

Expectations are important. Just imagine how you would feel if you expected a German chocolate cake from Neiman Marcus and only got a Twinkie from 7-11. You might lose your appetite for sugar . . . and for stocks.

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