Stock Market Behavior: How to Break Down the Relationship Between Market Activity and News
by Marc Lichtenfeld, Advisory Panelist
Wednesday, September 1, 2010: Issue #1337
Last weekend, I hosted a poker game with some friends. During one hand, I made a series of bets, which caused my opponent to think hard about it.
One of the other players coached him: “He’s trying to tell you a story with the way he’s betting. The question is, do you believe what he’s telling you?” My opponent believed me and folded. Good thing for him, too, as I had a full house!
Like a good poker player, the stock market is also telling us a story. The difference, however, is that the market is usually believable!
But here’s what many investors don’t understand: the market tells us the story of what will happen, not what has happened.
For example, my father is constantly asking me why the market was up or down on a certain day. Perhaps your family and friends do, too. But they’re missing the point.
Sure, the market sometimes responds to data or news. But it doesn’t usually react to the news. The news often reacts to the market.
Why? I’ll show you…
What Comes First… Stock Market Behavior or News?
The point about the “stock market behavior in relation to news” equation resonated with me when I listened to a fascinating speech by Elliott Wave Theory expert, Bob Prechter.
In this instance, though, Prechter didn’t discuss Elliott Wave. Instead, he showed the correlation between all kinds of data and events that took place after important moves in the market.
Take wars, for example. They tend to break out when the market is bad – something that makes sense when you think about it. When the market is down, people feel poorer and are more irritable. It’s easier to get them to support a war. Plus, elected officials want to distract the public from their economic woes.
There is a precedent for this theory…
I attended Prechter’s talk in the spring of 2001, as the market was in the middle of the dotcom collapse. In March 2003, the United States invaded Iraq. At that point, the market was down 45% from the highs of March 2000. I can’t help but wonder if that war would have ever been fought if we were still in a bull market.
Bulls, Bears and Birth Rates
Bear markets also spark decreases in birth rates.
Again, it makes sense that when people are less comfortable financially, they put off new financial burdens like a child. Not to mention, financial stress makes people less amorous.
The opposite is true of bull markets. During and shortly after bull markets, the birth rate usually rises.
I was reminded of Prechter’s talk last week when news came out that the U.S. birth rate was the lowest in history.
In 2007, for example – the top of a four-year bull market – there were 14.3 babies per 1,000 of the population. That year, more babies were born the United States than in any other year in America’s history.
But in 2009, the figure dropped to 13.5 babies born per 1,000 people. The marriage rate also decreased from 7.3 per 1,000 in 2007 to 6.8 in 2009.
Look Forward, Not Back
The fact that the stock market is a forward-looking mechanism makes me less concerned about every piece of economic news that the pundits use to justify their “next Great Depression” or “Big Bubble” theories.
Take 2008, for example. As the market plunged on the back of the financial crisis and several huge corporate meltdowns, it indicated that a nasty recession was on the way. In addition, it perhaps predicted an election victory for Obama, as he was perceived as anti-business.
But a funny thing happened. In 2009, the market rallied hard. The upward move in stocks suggested that the economy was no longer falling off a cliff. Yes, things were still tough, but the panic that many felt in late 2008 was no longer justified.
So what story is the market trying to tell us today – and how do we interpret the data?
Stock Market Behavior: Are You Asking the Right Question?
Currently trading around 1,050, the S&P 500 is down 16.1% from its late April high. So does it signal that a double-dip recession is headed our way?
If the index slips much further, I believe it does. However, if it can hold its current level and work its way higher, better days may be ahead.
The bottom line here is that the market predicts the country’s future economic direction, rather than news moving the market. So the next time stocks head in a certain direction, don’t ask, “What happened to make the market move?” Instead ask, “What is the market telling me is going to happen?”
Hoping your longs go up and your shorts go down.
Marc Lichtenfeld
Related Investment U Articles:
- Seven Signs This Bull Market Could Continue
- Can Monthly Jobs Data Make You a Better Investor?
- The Return of the American Consumer
- News Corp.’s Bad Publicity May Present an Opportunity
- The Four Investment Risks You Can’t Avoid
6 Responses to “Stock Market Behavior: How to Break Down the Relationship Between Market Activity and News”
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Marc is a senior analyst at Investment U. His investment career started out at the trading desk of Carlin Equities in San Francisco, CA, where he executed dozens of trades each day for his clients.
Hi Marc,
Enjoyed your article.
Your conclusion stood out – “The bottom line here is that the market predicts the country’s future economic direction”.
James Sinclair writes that Management of economic Perceptions is one of the most important tools the Fed has.
When one considers all possiblities of “control” – DTCC; PPT; 100% electronic reporting etc. What is there to prevent the Fed from literally painting whatever picture they like?
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There are too many external factors that would permit the markets to predict the future. It is like the family that has maxed out their credit cards, and can no longer service the interest on their debt. From their spending, one might surmise that all is well, and be predicting success for their future, but just the opposite is true. America has more than half the States in a deficit situation, a Federal Government that is having to buy its own debt, and a consumer that doesn’t have any money to spend. Regardless of what the markets say, all is not well.
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Marc, your comments strike me as “elegantly simple” and are echoed in Barton Biggs (a former colleague at Morgan Stanley) book “Wealth, War and Wisdom” as he recounts the major events of World War II and how they shaped the stock market and individual wealth from 1930 to 1945.
The interesting “take away” from the book is that the worldwide stock markets actually predicted the course of the war in a rather contrarian fashion. Very similar to your comments. Great article – Thanks!
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the article really was that boggles the mind, made us to think other way round.
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Very timely and well stated. News anchors will be sad to know they don’t control market movements.
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Hi there
Greetings from Kathmandu, Nepal
Great write up but what exactly is the Bond market telling us… in comparison to the stock markets the Bond markets are aleast supposed to have sophisticated people as markets participants. Ofcourse not all the rally in bonds could be leveraged speculation and easy money courtesy of the Fed otherwise the same participants can make or break any markets they feel like it. If the stock market is telling us something isnt the bond market telling us the same thing more tellingly… these are historic low yields on the short term variety in the face of what clearly is extra ordinary monetary expansion from the US and CHina and everything in between.. for the uninitiated Americans theres something called the Rest of the World in Between those 2 entities…
Best
Nitin
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