Expectations

The word that can mean so many things to so many people. Expectation! People that can set reasonable ones, and follow through tend to be more successful than people who cannot.

However, expectations REALLY matter in both marriage and economics. In marriage, should expectations not be met, it usually ends in divorce. In economic if expectations cannot be met, it ends in volatility.

Today was a classic example of just how important expectations are in the world of economics. But before we dive into today’s action, I want to impress upon you why expectations are so important in the world of finance.

For my example, let’s assume you are a scratch golfer. Let’s also assume you like to gamble. So, you set up a golf game with someone, who, through all of your research, experience, the rumours you have heard etc. is a 15 handicap golfer. So, you introduce a little wager on the game. Say $1,000.00. You are pretty confident in your bet, since you have done your homework. However, after the 1st tee it becomes quite apparent that the person you are playing is not a 15 handicap, but is rather a 2 handicap. Of course, all things being equal, you will lose you $1,000.00 now, and you are crushed.

Economics is the exact same way. Traders, take all of their info, research, rumours, and general senses of economic activity, and they place a wager. Of course they wager so that they will win, but sometimes when we see releases on GDP, inflation, company earnings, etc. you find out the economy is more or less handicapped than you bet on. Traders place their bets, months, day, weeks, and hours before important data, so when the expectations are too far from the general consensus, then calamity ensues.

So, let’s turn our attention to some of today’s action. First up we had the Canadian GDP report. Gong show doesn’t really even begin to describe this. So, Q3 GDP was EXPECTED to come in at .20% for the quarter, but actually SHRANK by 1.06%. Remember that GDP is the total of all goods and services sold, so basically, for easy math, it is the value of all money spent. It was a massive miss from the expectations, and more importantly, while the consensus called for growth, it was actually negative. For the record, the BOC expectation for Q3 was growth of .80%. When you are talking about the total of all goods and services , a difference from .80% to -1.06% is billions of dollars. Okay, cool, but then why the hell was the Canadian 5 year bond yield up on the day? Shouldn’t contracting GDP mean a recession, and mean rates are coming down? Well, yes, but the bond went up today. Why?

In the same GDP report, Statistics Canada also revised the Q2 GDP from a negative .20% to a positive 1.40%. So, basically the past wasn’t as bad as the past was made out to be. Of course, by revising the Q2 GDP into positive territory, we also magically have now avoided the technical definition of a recession ( 2 back to back quarters of negative GDP growth ). I am not accusing the government of manipulating or massaging numbers, but I also don’t believe in coincidences. Whether they massaged or smoothed out the data, the fact that both of these quarterly numbers are so far off, proves that even the people in charge don’t have a friggin clue what is going on. For the data trifecta, we also had the ” Flash Oct GDP ” which is basically the pre approval mortgage of the data world. They take a quick glance, but not an in depth look, and the flash number showed October GDP to be slightly higher than expected at .20% month over month, rather than the EXPECTED .10% month over month. Of course, data is revised more on these economic reports than a kid trying to pass a multiple choice high school math exam, so I wouldn’t read a whole lot into the flash GDP.

Again, when all the bankers, traders, and market participants had placed their bets going into the GDP report, quite a few were found offside of their little golfing wager, and had to re allocate. The 5 year yield was up because it was oversold on the crowd betting on back to back declining GDP, so the news today was simply ” less worse” than expected. Either way, it matters not what the number is, it only matters what everyone thought the number was going to be, and how their wagers were loaded. The Canadian dollar also picked up a little pep in its step off the less worse news from Q2, and the positive Flash Oct report.

For a little contrast though, the US also revised their q# GDP today. It went from the initial reading of 4.9%, and was revised up to 5.20%. No matter how you slice it, the US economy is firing on all cylinders and outpacing the Canadian economy in leaps and bounds. I Expect this to continue over the coming couple or few quarters. I have wagered accordingly, however, as we can find out any day – I could be wrong, and I could be golfing with Tiger Woods. Just because you may be right on direction, you may be wrong on velocity. Just because you nailed the current direction, the past might come back to bite you. And of course, all of the data is subject to seasonal adjustments, revisions, and incompetence. This is what makes economics so hard, and so complex. You not only have to get the direction correct, you also have to get the timeline bang on.

Expectations rule supreme, and our business is no different. When we meet with our clients, how we set their expectations will determine the outcome. Make sure you know where the clients expectations for the transaction, your services, rates etc is currently, so as to avoid finding out your client is a 2 handicap, when you thought they were a 15.