Sentiment Speaks: Here Is Next Week's News In Advance - How Will You Trade It?

Summary

  • How would you trade if you had the news in advance?
  • The truth of how the market would react will shock you.
  • You may want to consider abandoning trading the substance of news events after you read this article.

The great majority of market participants believe that "the fate of markets is inextricably intertwined with the ebb and flow of geopolitics." So, if I share with you "secret" news that will hit the wires next week, you should be able to make a killing with such information. Right?

While I strongly disagree with this proposition, at least based upon my in-depth study of decades of stock market history, this perspective is so ingrained in the investment process of advisors and analysts alike that it is followed even more than the Bible.

So, let's test this proposition.

Let's say that today is Nov. 25, 2017. And, I will guarantee that, on Nov. 28, 2017, North Korea will launch an ICBM towards Japan, one of the main allies of the United States. In fact, Japan will issue an emergency warning, telling its citizens to seek shelter. How would you trade that news?

Well, I am quite certain that at least 95% of you would short the market before it closes the day before Nov. 28, expecting that you are going to make a killing after that geopolitical news hits the wire. Well, I hate to tell you this, but you would have been taken to the cleaners in your shorts, as the market not only did not fall after that news, but instead it rallied 60 points after that news hit the wires.

Now, I am going to challenge each and every one of you who so desperately believe that news causes changes in the stock market. We all know that the Sept. 11th terrorist attack was one of the worst in recent American history. So, those that believe these types of events have a dramatic negative effect upon our markets will certainly be able to pick out where it occurred on a chart since it was the most significant event of our time - right?

Now that you probably assumed it occurred somewhere near the highs of this chart and caused that entire decline, allow me to show you where it really occurred:

As you can see, we were already in a multi-year decline when 9/11 occurred, and we were closer to a bottom in the market than a top. Moreover, there were even larger drops seen during this downtrend than the one "begun" on Sept. 11th.

In fact, the market bottomed the week after the event, and then rallied to a level 10% higher than where we were right before 9/11. Maybe we can actually say that 9/11 caused the selling capitulation we often see at a bottom to the market, and then caused a 20% rally? Well, the facts support such a conclusion, even though the predominant presumptions about how major news events affect the market do not.

As I have noted so many times before, this "religion" of correlating news to major directional moves in the market leads many analysts to even force a news event to be the cause of a market move. In fact, it is almost laughable to see how analysts hopelessly attempt to explain what the market did yesterday by fitting their square pegs of linear reasoning into the round holes of non-linear market action. Let's be honest, how many times have you heard the most ridiculous reasons trying to explain what the market did on a given day? And, even though the reasons are provided after the fact, oftentimes it still sounds ridiculous.

Here is a perfect example where opposite market movements are being explained by the pundits with the same rising interest rates:

Or, how about opposite reactions of the gold market to the same news of inflation occurring within one day of each other:

Recently, the market dropped for a day due to Starbucks (SBUX) closing its doors that day, as investors were unable to get their caffeine fix. While you thought it was due to issues in Italy, you would be wrong. You see, when Starbucks re-opened, the market went right back up to exactly the point from which it dropped, even though the Italian issues were not resolved. So, it clearly had to be driven by the Starbucks events rather than the Italian one. While I am using this example in a sort of tongue and cheek fashion, are you starting to see my point?

I have quoted him many times in the past, but I believe Professor Douglas, with his incredibly impressive credentials, strikes this point home so well. In a paper written by Professor Hernan Cortes Douglas, former Luksic Scholar at Harvard University, former Deputy Research Administrator at the World Bank, and former Senior Economist at the IMF, he noted the following regarding those engaged in "fundamental" analysis for predictive purposes (emphasis added):

The historical data say that they cannot succeed; financial markets never collapse when things look bad. In fact, quite the contrary is true. Before contractions begin, macroeconomic flows always look fine. That is why the vast majority of economists always proclaim the economy to be in excellent health just before it swoons. Despite these failures, indeed despite repeating almost precisely those failures, economists have continued to pore over the same macroeconomic fundamentals for clues to the future. If the conventional macroeconomic approach is useless even in retrospect, if it cannot explain or understand an outcome when we know what it is, has it a prayer of doing so when the goal is assessing the future?

Please read that last sentence again, as it is key for you to understand the folly of common market analysis:

If the conventional macroeconomic approach is useless even in retrospect, if it cannot explain or understand an outcome when we know what it is, has it a prayer of doing so when the goal is assessing the future?

You see, there are multiple problems with utilizing this type of analysis for prognostication purposes, which ultimately points out that it is not an intellectually honest way to attempt to prognosticate the market. First, you would need to know the news in advance of the market action in order to prognosticate. Second, you would have to assume that the substance of the news would cause a "logical" reaction in the market. But we cannot know the news in advance of it occurring, and history has shown us that, even if we knew the news beforehand, the market does not always react in the "logical" manner. In fact, based upon many studies of market history, it rarely reacts in the "logical" manner.

In a 1988 study conducted by Cutler, Poterba, and Summers titled "What Moves Stock Prices," they reviewed stock market price action after major economic or other type of news (including major political events) in order to develop a model through which one would be able to predict market moves retrospectively. Yes, you heard me right. They were not even at the stage yet of developing a prospective prediction model.

However, the study concluded that "[m]acroeconomic news ... explains only about one fifth of the movements in stock market prices." In fact, they even noted that "many of the largest market movements in recent years have occurred on days when there were no major news events." They also concluded that "[t]here is surprisingly small effect [from] big news [of] political developments ... and international events." They also suggest that:

The relatively small market responses to such news, along with evidence that large market moves often occur on days without any identifiable major news releases casts doubt on the view that stock price movements are fully explicable by news...

In August 1998, the Atlanta Journal-Constitution published an article by Tom Walker, who conducted his own study of 42 years' worth of "surprise" news events and the stock market's corresponding reactions. His conclusion, which will be surprising to most, was that it was exceptionally difficult to identify a connection between market trading and dramatic surprise news. Based upon Walker's study and conclusions, even if you had the news beforehand, you would still not be able to determine the direction of the market only based upon such news.

In 2008, another study was conducted, in which they reviewed more than 90,000 news items relevant to hundreds of stocks over a two-year period. They concluded that large movements in the stocks were not linked to any news items: "Most such jumps weren't directly associated with any news at all, and most news items didn't cause any jumps."

So, despite what these, and many other studies of market history have shown, what do analysts that believe "the fate of markets is inextricably intertwined with the ebb and flow of geopolitics" do? Well, in the rare times when the market does react in a "logical" way to the substance of the news, they highlight that front and center, and make sure we all understand how the market reacted logically to the particular news event. And, most will even claim that it is "obvious" that the news caused the market move, and imply that we are troglodytes if we do not accept this causative linkage.

But, when the market does not react in a "logical" way (which is greater than 50% of the time based upon actual market history), they either ignore the news or make up some other reason as to why the market ignored the news: "the market sold the news," "investors shrugged off the news," "the market already discounted the news," "[another fundamental factor] was more controlling," etc. So, in my humble opinion, this is not an intellectually honest way to analyze our markets.

Now, for those that are still unconvinced, how many of you expected that the market should have hit its high at Brexit, or Frexit, or after the various terrorist attacks we experienced the past few years, or the Fed ceasing QE, or interest rate hikes, or the Trump election, etc.?

The great majority expected each of these individual events to have "caused" the top to the market from a long-term perspective. Yet, even taken cumulatively over the course of the last two years, the market still experienced a 40% rally, and one of its strongest rallies in its history.

At the end of the day, I think it is abundantly clear to anyone who is willing to look at the market from an intellectually honest perspective that the fate of markets is not inextricably intertwined with the ebb and flow of geopolitics. You see, the market has proven it just does not care if you have actually been listening to everything the market says, and not just pick and choose what you want to believe.

So, as an investor, you have a choice. You can choose to continue reading analysis that ineffectively and hopelessly attempts to explain what the market did yesterday by fitting the square pegs of backward-looking linear reasoning into the round holes of non-linear market action. Or, you can recognize, as Alan Greenspan did, that markets are driven by "human psychology" and "waves of optimism and pessimism," and learn how to track what really drives the market. It's up to you.

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This article was written by

Avi Gilburt profile picture
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The #1 Service For Market and Metals Direction!
Avi Gilburt is founder of ElliottWaveTrader.net, a live trading room and member forum focusing on Elliott Wave market analysis with over 6000 members and almost 1000 money manager clients. Avi emphasizes a comprehensive reading of charts and wave counts that is free of personal bias or predisposition.

Avi is an accountant and a lawyer by training. His education background includes his graduating college with dual accounting and economics majors, and he then passed all four parts of the CPA exam at once right after he graduated college. He then earned his Juris Doctorate in an advanced two and a half year program at the St. John’s School of Law in New York, where he graduated cumlaude, and in the top 5% of his class. He then went onto the NYU School of Law for his masters of law in taxation (LL.M.).

Before retiring from his legal career, Avi was a partner and National Director at a major national firm. During his legal career, he spearheaded a number of acquisition transactions worth hundreds of millions to billions of dollars in value. So, clearly, Mr. Gilburt has a detailed understanding how businesses work and are valued.

Yet, when it came to learning how to accurately analyze the financial markets, Avi had to unlearn everything he learned in economics in order to maintain on the correct side of the market the great majority of the time. In fact, once he came to the realization that economics and geopolitics fail to assist in understanding how the market works, it allowed him to view financial markets from a more accurate perspective.

For those interested in how Avi went from a successful lawyer and accountant to become the founder of Elliottwavetrader.net, his detailed story is linked here.
Since Avi began providing his analysis to the public, he has made some spectacular market calls which has earned him the reputation of being one of the best technical analysts in the world.

As an example of some of his most notable astounding market calls, in July of 2011, he called for the USD to begin a multi-year rally from the 74 region to an ideal target of 103.53. In January of 2017, the DXY struck 103.82 and began a pullback expected by Avi.

As another example of one of his astounding calls, Avi called the top in the gold market during its parabolic phase in 2011, with an ideal target of $1,915. As we all know, gold hit a high of $1,921, and pulled back for over 4 years since that time. The night that gold hit its lows in December of 2015, Avi was telling his subscribers that he was on the phone with his broker buying a large order of physical gold, while he had been accumulating individual miner stocks that month, and had just opened the EWT Miners Portfolio to begin buying individual miners stocks due to his expectation of an impending low in the complex.

One of his most shocking calls in the stock market was his call in 2015 for the S&P500 to rally from the 1800SPX region to the 2600SPX region, whereas it would coincide with a “global melt-up” in many other assets. Moreover, he was banging on the table in November of 2016 that we were about to enter the most powerful phase of the rally to 2600SPX, and he strongly noted that it did not matter who won the 2016 election in the US, despite many believing that the market would “crash” if Trump would win the election. This was indeed a testament to the accuracy of the Fibonacci Pinball method that Avi developed.


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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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