Investment U E-Letter: Issue #563
Wednesday, July 26, 2006 Lord Rothschild's Investment Advice: Why It's Best to Sell at the Sound of War-Time Trumpets
by D.R. Barton, Advisory Panelist, Investment U Some pundits and investors are salivating… They believe that good news on one or both of a couple key looming events will be enough to send the market soaring skyward. But watch out. History tells a different story. Indeed, history has proven over and over again that the market is highly temperamental, and that when there is seemingly good news, it often reacts negatively. But why? What causes such unpredictable behavior? Today, with the help of legendary contrarian Lord Rothchild's investment advice, we'll look at why this happens and what we can expect in the coming days and weeks. First, let's take a look at the two factors that have some folks fooled… Listen to Lord Rothschild… and Don't Fall for These Two Myths First, you've got the current hostilities between Israel and Hezbollah. Many are worried that the fighting could escalate and spill over into other countries in the Middle East. But others hope for a cease-fire and further hope that an end to the hostilities could be the catalyst the market needs to send it skyward. Don't count on it. As Lord Rothschild once advised (paraphrased): "Buy on the sound of the war-cannons; sell on the sound of the victory trumpets." You would do well to heed this legendary speculator's contrarian advice. The second piece of potential good news on everyone's radar screen is that the Federal Reserve has recently dropped not-so-subtle hints that that it will finally take a rest from its incessant rate hikes. Everyone expects that when the Fed stops tightening, the market will spread its wings and fly. Once again, don't be surprised when the good news myth gets busted, and the stock market performance doesn't meet the expectations. But some investors do get fooled every time. The anticipation of market-moving news gets them excited, but is soon punctured shortly thereafter with lots of disappointment. This pattern repeats itself over and over. Here's why you should pay attention to Lord Rothschild's savvy piece of contrarian advice when he suggested that the best play is to fade (or go against) the good news at the end of a conflict… Follow Lord Rothschild's Contrarian Advice… Sell Your Investments on the Sound of the Victory Trumpets It's useful to understand the market this way: It acts as a round-the-clock valuation mechanism. It constantly asks the question, "What is the value of Event X in the future?" And it immediately answers that question in the form of a price. The event in question may be a company's earning report. The market would ask: - What is the likelihood that the company will exceed its earnings projections?
- What is the likelihood that it will underperform?
- What would either of those events mean in terms of the stock price?
As you see so often, with every little hint of better performance, stock prices jump. And with any suggestion of a letdown, prices drop. All of this happens on rumors and inference. The end result? By the time earnings are actually announced, the market has already digested almost all the possible information about the earnings announcement and valued the stock accordingly. So the only way the stock's price will move significantly is if there is a surprise. Then there is the "myth of good news" - another factor that often shocks people. For example, the stock's earnings report is released, showing that the company met expectations, earning five cents a share. The public thinks this is good news and expects the stock to rise. But in a pattern we see over and over again, the stock may move up for a short while, only to start dropping, despite the good news. Why? Because the news was already calculated into the price by the markets valuation mechanism. The good earnings were expected. The price had already been adjusted to take those earnings into account. And when the company announced that expectations were met, there was no new good news. So any chance for even better news is lost and the price trickles lower. The Key to Understanding News and The Market's Reaction So next time good news hits and the share price still goes down (usually after a very short spike up), you'll know why. Here's the key: If the market has already anticipated good news, the actual news will have little effect on prices, or will even have a negative effect. To clarify this, let's look at a couple of examples: - End of War: The classic example comes following the cease-fire in the Vietnam conflict. After prices spiked briefly, they headed down. While the ceasefire was good news, it was expected. Lord Rothschild's investment advice was spot-on again…
- End of Federal Reserve Tightening: Jason Goepfert, the excellent sentiment analyst, has conducted some compelling historical research on what happens after the Fed stops raising interest rates. In the six months after the end of a tightening cycle, there is strong support that shows stock prices dropping. So be aware that one of this year's most anticipated events (the end of the Fed's interest rate hikes) may bring more disappointment than expected.
Here's what you need to remember: While you might expect the market to soar skyward on good news, if that news was expected, the euphoria is usually short lived and brings only a temporary spike to the market and prices. So don't get caught up in the emotions of the moment when the good news - which everyone was expecting - finally comes. Great trading, D.R. Barton Today's Investment U Crib Sheet- While it's nearly impossible to predict the end of the violence overseas or the end to the Fed's rate hikes, one thing is clear: the uncertainty is clouding strong corporate earings growth, share buybacks and dividend boosts throughout the market. But regardless of the current conditions, many companies are experiencing high returns right now. The Oxford Club's Anti-Terror Portfolio contains stocks that turn in strong results in every market condition. In fact, these stocks can actually outperform in times of uncertainty. (The portfolio is up 93.59% since its inception.) Learn more about The Oxford Club.
Related Articles Investment U Archives 
| 
