Sunday, November 01, 2009

Does News Drive the Markets? A Closer Look at This Old Wive's Tale

With the markets at a potential inflection point (an inflection point down, in my humble opinion), I thought it'd be fun and instructive to revisit a topic we've noodled on a bit lately.

Does News Actually Drive the Financial Markets?

It's common knowledge that increasing earnings drive stock prices - with the only caveat being that there's no evidence of this being true. A couple of weeks ago, we posted a short guest article that challenged this assumption, making the case that stock prices actually drive earnings, not the other way around.

Since I'm becoming more and more sympathetic to this outlook of the markets driving the news, I thought it'd be a fun exercise to take a closer look at this hypothesis.

To be as objective as possible, I conducted a few searches using the Google News search function, so that we could count up the number of stories that contained my search phrase. First up...

Bear Market Rally

Stories about the bear market rally have tapered off - it's a new bull market!
(Source: Google News)

How ironic that the number of news stories about a "Bear Market Rally" peaked in March...the month the rally was just beginning! Being a somewhat disparaging term, I find it fitting that the use of this phrase in news headlines has dissipated as the markets have rallied.

I'd imagine the reason is this rally no longer viewed as a mere bear market rally, but a new bull market! Probably just in time for the markets to turn down once again.

The grand prize goes to the Financial Post, for their March 5th article Talk of a 'bear market rally' may be premature. It sure was - by about 24 hours!

Bond Vigilantes

Why do interest rates rise and fall? It's a complex question - one that appears to be too complex for the news headlines to adequately explain!

In June, the return of the "bond vigilantes" was a popular reason for soaring yields on long dated US government bonds. The bond markets were pissed, and ready to raise hell about soaring government deficits.

The only problem about investing based on the "news" that the bond vigilantes had returned, ready to drive up yields further, is that your timing would have been exactly wrong.

Yields topped along with this news, and both have quietly rode off into the sunset since.

2009 news about the "Bond Vigilantes" peaked in June.
(Source: Google News)


Right along with yields
(Source: Yahoo Finance)

Dollar Reserve Currency

Here's one near and dear to my heart - the overblown reporting of the dollar's reserve currency status being in imminent danger. You'll notice there was a low, steady hum of stories - up until March of this year, when the dollar topped out (for the time being).

News of the dollar's demise really picked up AFTER it started to decline.
Source: Google News

Since then, the dollar has been declining, and stories of the dollar being replaced as the world's reserve currency have been all over the financial media. My favorite was a recent story in London's Independent entitled The Demise of the Dollar, which may have coincided with a significant bottom in the dollar index, which has rallied steadily since!

Bottom line: Using the news to trade is a losing proposition...you'd be much better off using the charts to predict the news. The financial news media is a fantastic example of groupthink at it's best, or worst, depending on your perspective.

You can always count on financial news stories to break after the market has already tipped it's hand!


The Start of a Larger Decline?

Many of the technical indicators I follow appear to be signaling a shift is taking place in the markets, in which the dollar will once again reign supreme, and everything else should roll over. In other words, an instant replay of the last bit of deleveraging, though probably worse.

To get the "average investor" sentiment after Friday's big decline, I pulled up one of our favorite contrarian indicators, the Wall Street Journal, to see what they were recommending. It's said that bull markets often climb a "wall of worry", so my thinking was that if they displayed a "run for the hills" sentiment, that may indicate that this is just a correction on the way up.

Much to my delight (because I'm short the markets, as you see below), the article I pulled up from the front page expressed optimism that this pullback represents a nice buying opportunity.

Even some of the optimists think it would make sense for stocks to fall as much as 10% before they resume their gains.

The bullish tone and level of confidence being exhibited by investors is truly awe inspiring, given that most investors lost 40% of their porfolios in the previous crash. That says to me that this bear market rally has completed it's mission, and we should prepare for the next leg down.


Positions Update - Long the Buck, and Now Short the S&P

At last - a positive week for the dollar! And no coincidence that, meanwhile, stocks got slaughtered. A sign of things to come? I think so!

On Thursday, I shorted the S&P, thus far successfully. I think over the coming months, you may be able to short just about anything and do pretty well. Long the dollar, short everything else - that's my recommendation until further notice.

The dollar - gearing up for another megarally?
(Source: Barchart.com)

Open positions:


Thanks for reading!

Current Account Value: $25,969.68

Cashed out: $20,000.00
Total value: $45,969.68
Weekly return: 8.8%
2009 YTD return: -48.9%

Prior yearly returns:
2008: -8%
2007: 175%
2006: 60%
2005: 805%

Initial trading stake: $2,000.00

3 comments:

Brian said...

Your Long USD position will start to work out.

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