Factors That Affect The Stock Market

Factors That Affect The Stock Market: The Only 2 Things That Drive The Markets

By Dr. Steve Sjuggerud, Advisory Panelist, Investment U
Thursday, June 20, 2002: Issue #148

There’s such a glut of information these days: monthly investment magazines covering the markets daily investment newspapers doing the same and minute-by-minute coverage on CNBC. They’re all trying to tell you what’s driving the stock market, and they all love to tell you where the market is going to go. And much of the time, they’re wrong! It’s enough to drive you crazy!

I’m going to make your life a lot easier. Of all the factors that affect the stock market, only two things drive the markets. And you don’t need to check in on CNBC, newspapers or magazines to follow them. Just two things drive the markets; I call them The Two “E’s.”

The Two E’s… And How They Affect The Stock Market

The first “E” you can probably guess. The second “E” you probably wouldn’t guess right away, but it’s equally important and it’s much less talked about. Since that’s the case, we’ll spend a little more time on the second “E” today

The first “E” is earnings. Everyone talks about this “E,” and it is extremely important. The big question here is: What is the stock price in relation to the company’s earnings? That tells you, in general, whether a stock is cheap or expensive. This is what we need to know and the information is easy to find.

In my research, I’ve found that, throughout history, you don’t make money in the stock market when the price-to-earnings ratio of the 500 biggest companies in America is above 17. Today, that number is gulp about 40. (You can follow this number at http://www.spglobal.com/earnings.html; use the “as reported” number.)

What you need to realize here is that, unless stocks fall by over 50% - or unless earnings more than double - you don’t even need to check in with this number. You know that stocks are expensive in relation to their earnings, and will be for a while. Just remember, history tells us we don’t make money in stocks when the price-to-earnings ratio of the market is above 17. I won’t say more here because so much is said and written on the topic of earnings in the mainstream financial press already.

The Second Factor that Drives the Markets Is EMOTIONS

Emotions are a huge part of investing. Do you think it was earnings that drove the Nasdaq from 1,500 to 5,000, and then back to 1,500, all in four years time? Did earnings get 200%+ better? And then 70% worse? No. Was the Crash of ‘29, where stocks ultimately fell by 89%, due to earnings? No. Emotions played a big part in both of those examples.

The 10 Stages Of The Stock Market

Human beings, with both rational and emotional urges, are the market players. And the thing is, those emotional urges can (and do) often overtake the rational side.

Instead of explaining this at great length, it’s better if you just read my “10 Stages Of The Stock Market” below and figure out where we are right now. This “10 Stages” model is a tool for measuring the “emotional state” of the market today.

What are your friends and neighbors saying about the stock market? Ask them. Then figure out which quote below best sums up all their emotions. By doing this, you’ll know exactly where we are in the stock market. Of course, you’ll want to be a buyer somewhere around the end of the bear market and the beginning of the bull market.

Please read these “10 Stages,” and think about where you think we are now. When you do this, you’ll know where we are in this market.

BULL MARKET, LATE STAGE: “Darn it, other people not as smart as me are getting rich, and I’m just sitting here. I’ve got to get in on that!” (Late 1990s?)
BULL MARKET, PEAK: “Man, I am SMART. I’ve made a ton of money in stocks. And it couldn’t have been any easier. Practicallyeverything I buy goes up!” (Early 2000?)
BEAR MARKET, BEGINNINGS: “It’s just a correction. Buying the dips has worked like a charm in the past, and it’ll work again!” (Late 2000?)
BEAR MARKET, EARLY STAGE: “They say to buy and hold, so that’s what I’ll do, just keep on holding it’ll come back!” (2001?)
BEAR MARKET, MIDDLE STAGE: “The correction HAS to be almost over by now. I’d sure hate to sell out right at the bottom, only to have the market roar back.” (Early 2002?)
BEAR MARKET, LATE STAGE: “Well, it’s too late to sell now. So I’ll just keep holding. Boy, I used to open my portfolio statement the second it came in the mail just to see my net worth going up, up, up! Now I dread opening my mailbox.” (Late 2002?)
BEAR MARKET, PEAK: “Okay, I give up. It’s time to start cleaning house and sell these stocks. Boy I really shouldn’t have put so much money into these things.” (Early 2003?)
BULL MARKET, BEGINNINGS: Nobody EVER makes money investing. I’ll never put any money in the stock market ever again. (When???)
BULL MARKET, EARLY STAGE: “Wow, prices have been going up lately. I hadn’t even noticed - I’d given up. Those foolish buyers, they’ll sure get what’s coming to them! I’m going to get out now, while things are up!” (When ???)
BULL MARKET, MIDDLE STAGE: “Hey, things are looking up. Maybe there is something going on here Nah, once burned, twice shy! I’m skeptical - I’ll keep watching this sucker’s rally!” (When???)

By reading these objectively, I’d say we’re at about 5 right now, which means we’re in the middle stage of the bear market. (The problem is, you never know how long one stage will last.) I hear everything from 4 to 6 regularly these days. What do you think? (Incidentally, the absolute best time to buy is between stages 7 and 8.)

Good investing,

Steve

Today’s Investment U Crib Sheet

All you need to know about where we are in the market right now is The Two “E’s.” As for the first “E” -earnings - it will be years before stocks look good by that measure. As for the second “E” - emotions - just follow my “10 Stages of the Stock Market.” Then you’ll know when stocks are attractive to buy again.