If you've followed the stock markets in recent months, you may have asked yourself the same question a reader sent to EWI's Message Board:
Markets have been moving up across the world for the last four months now, amidst the news of deteriorating employment, bankruptcies, huge fiscal deficits, etc. With all this bad news how can the human herd's sentiment become positive and push the markets up like it has been?
The vast majority of investors and analysis firmly believe that economic fundamentals drive trends in the stock market. For them, there is no good answer to our reader's question. Want to hear the answer that does explain this paradox?
It's pretty radical: The economic situation does not create stock market trends. It lags them.
For a more complete explanation, let's turn to EWI's president Robert Prechter. Bob has written and said a lot on this crucial topic. Here's an excerpt from his interview published in Prechter's Perspective:
You don’t consider fundamentals?
Bob Prechter: On the contrary, socionomists, as I call us, are the only ones who do so properly. The patterns of social psychology that occur naturally are the fundamentals of the market. They are what cause what most people think are the fundamentals.
On Wall Street, analysts contemplate the ramifications of events in Washington, Tokyo and all points in between... Then they proceed to build a market opinion... They say, “The Democrats are going to win, and the president is going to do such-and-such, and that’s going to cause stock prices to...”
BP: Right. And they have about as much success predicting markets as economists have predicting the economy.
[Elliott wave patterns are] an elegant idea, but in the workaday world of Wall Street, the average broker or economist or reporter is going to say, “Ellio-huh? The Fed just raised interest rates.”
BP: And what do they say when the market goes up despite a rise in rates?
They don’t talk about it.
BP: Right. They find a different event they perceive as positive and say the market went up today because of that. I may present a radical theory of social causality, but it is the only one that makes sense. The Wave Principle presents a profound truth: sometimes the dynamics of social psychology are impelling the mass mood toward optimism, and sometimes toward pessimism, regardless of all news. Events do not shape the market; it’s the forces behind the market that shape events. Events are results, and when you know what they result from, i.e., social mood trends, you can often predict the general tenor of such behaviors. If one knows the species of a tree, he can predict what kind of fruit it will bear. Events are the fruits of a bull or bear market in social mood.
But we’ve all seen the stock and bond market bounce or dive on the release of money supply or Consumer Price Index figures.
BP: Sure, for a few minutes. And sometimes it doesn’t react, does it? The release of such figures never changes the market’s larger trend. On all time horizons longer than two minutes, news lags the market.
Once you can demonstrate to yourself that the stock market has a life of its own, you will begin to feel that it is the guys poring over each new statistic relating to the course of the economy who are the real “tea leaves and entrails” bunch when it comes to anticipating the next move in the stock market. Conventional analysis is not a sound, reasonable approach; it is nonsense. It does not analyze the fundamental; it analyzes the extraneous.
“Economic forecasting,” goes the old joke, “is like trying to drive a car blindfolded and following directions given by a person who is looking out the back window.” With the Wave Principle, we are no longer driving blind. We can see enough about the road ahead to negotiate the car.
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