When The Market Says, “Jump!” The Economy Asks, “How High?”
Tuesday, August 12, 2008: Issue #548
by Marc Lichtenfeld, Senior Analyst, Smart Profits Report
One of the most fascinating lectures I’ve ever sat through came early in my career. On the stage… renowned Elliott Wave Theory expert, Bob Prechter.
The fact that I think this way is all the more surprising, since I actually don’t believe in Elliott Wave Theory. In case you don’t know, the theory suggests that the stock market moves in a series of repetitive, predictable waves - a five-wave move when trading upward and a three-wave move when trading downward.
But Prechter’s talk that day did not focus on Elliott Wave Theory. Instead, he showed that markets do not respond to macro events. In fact, just the opposite - the market is an excellent predictor of economies and world events, with the economy typically following the market’s lead 6-9 months later.
Here’s his reasoning…
The Market Predicts The Economy, Not The Other Way Around
In his talk, Prechter detailed how during bull markets (and up to about nine months after them), birth rates go up. And during bear markets, wars get started and missile testing increases. Most importantly, Prechter said that markets tend to predict the economy’s activity several months in advance.
So when a significant event occurs, take a look and see how the market responds. If it shrugs it off, then that may not be too important to the markets.
I bring this up because after picking up the newspaper this weekend and reading the details of the Russian attack in Georgia, I said to my seven-year old son and four-year old daughter, “This is going to be significant. Gold and oil are going to be up big on Monday.”
After all, I reasoned, when Russia starts a war, that’s important stuff, right?
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But the oil and gold markets didn’t really think so. They both responded in much the way as my children did: With complete indifference.
So what’s the deal here?
Don’t Question The “Why”… Just Be Prepared To Respond To It
How can the oil and gold markets not care that Russia has invaded a sovereign nation and attempted to disrupt its oil transport lines? Surely, both oil and gold would respond to that and prices would rise. The fact that they didn’t made absolutely no sense to me.
But you know what? It doesn’t have to make sense. The market doesn’t answer to me or any of us. We don’t necessarily need to know why. Instead, our job is merely to see the way the market reacts and take action.
Now, it’s only been two business days since this all went down, so we need to give it some time to play out and see what happens. But the preliminary indications are that this situation is not going to have a major impact on markets or our economy.
An Early 2009 Rebound On Tap?
I’ve also been wrestling with the question as to whether we’ve hit a bottom in the markets. Strong action in financials, consumer discretionary stocks and transport shares seem to indicate that the economy could be in store for a rebound in early 2009.
Of course, that’s if the rally holds up. Bear markets are notorious for sharp rebounds that suck investors in, only to decline again. At this point, however, I think it’s OK to be a little more optimistic that the U.S. economy will pull itself back up next year. Just don’t get carried away yet, though. It’s a long road ahead and we must wait for the market to sound the all-clear before we can feel more confident.
Marc Lichtenfeld
Today’s Smart Profits Notes
- June saw a long-awaited rebound in the housing market, with the news that home prices edged up 1.1% from May’s demoralizing 20.1% plunge and April’s 3.2% drop. However, the fact remains that prices are still down 11.5% on average from this time last year, according to the Integrated Asset Services House Price Index, amid the real estate market’s worst slump since the 1930s. The Midwest region led the sector higher, with home prices up 4.7% in June.The more widely followed Standard & Poor/Case-Shiller home price index showed that home prices in the 20 U.S. metropolitan areas fell 0.9% in May, and down 15.8% on the year.Meanwhile, the national Association of Realtors reported last week that the number of home sale contracts in June climbed to the highest level since October. The group also said the number of pending home sales also appears to indicate that the market is at least attempting to stabilize.
- While the depressed state of the U.S. dollar continues to make headline news, America’s manufacturers and exporters are enjoying the ride. With their goods cheaper abroad, exports rose by 4% to a record $164.4 billion in June - the biggest rise since 2004. As a result, the U.S. trade deficit dropped by 4.1% - from $59.2 billion in May to $56.8 billion in June. It’s the smallest deficit in three months and handily beat the $61.5 billion consensus estimate from Wall Street.
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