I have been meaning to write about this for a while, but in a few words watch what news you trade and what keeps you seated. We got a great example of that this weekend, when Japan released “disappointing” GDP data of 2.3% annualized contraction over the previous quarter, compared to estimations of 1.3% contraction.
For the mathematically reclined, I guess it was a selling opportunity, while the mathematically inclined might have been a little bit more enthusiastic and hopefully snapped up the new asks to sell flooding the market. Here’s the math and the details you need to read it properly:
First, keep in mind: 1) prior quarter GDP growth was previously estimated at 5.6% annualized rate, 2) the first link will show this was now revised to 7.0% growth, and that 3) these are quarter-on-quarter numbers, taken +1 and raised to the power of 4 to arrive at annualized numbers. these are not comparisons with previous months last year or whatever else you can think of. It’s the closest quarter-on-quarter approximation to the mathematical definition of the derivative of the GDP of the economy.
Now think. Previous quarter got revised up 1.4% in annualized terms. And expectations of the current quarter were optimistic by 1%. So the actual level of annualized GDP was 0.4% higher than expected! Now, tell me why the market went down on this news again.
Ok, ok, I kid. Most people are not mathematically inclined whatsoever. I can also see the point from people that analyze it from a deeper level than this post: bigger swings are not good in general over the path of a long term investment (check: leveraged ETF’s and why they’ll lose you your shirt no matter what the market conditions if you use them for longer than a week) and Japan isn’t really the risk asset attractor (yet) outside of some speculative currency traders. I also like differential equations a bit more than the next guy, so the volatility premium and extra costs that this incurs on anything else than pure cash-invested positions certainly ring a bell with me. A derivative is also always a derivative, and it was 75% steeper downwards than expected.
But still, seriously guys, the GDP was annualized a 0.4% better than you expected (out of Japan of all places) and analysts still think it looks set to clock in right beneath the US in total for 2012 from the last paragraph in the Bloomberg post. I think that’s a little bit more important than any headline figures and forecasts on iffy volatility models or ideas about mathematical derivatives. Remember people, if you can’t neutralize in base effects, do not try anything as advanced as calculus, or peering into statistics.
Of course, for a whole host of policy intervention reasons, you would have been making money trading this, but it still shows that the Japanese economy is stronger than what anyone who writes headlines is willing to admit, or could care to get their readers to understand. What annoys me most right now is the currency loss, however, but I expect that to be temporary. LTRO and QE3 here we come!