Last Friday (January 29) was a great day to watch the stock market and compare the price action against the explanations from analysts.
The day started with a bang: a 5.7% jump in the Q4 U.S. GDP. The DJIA gapped up at the open and quickly gained over 100 points. "Stocks Get Up and Go With GDP," said a headline around 11 AM. "Strong advance GDP growth in the fourth quarter, a jump in regional business activity in the Chicago area and a better-than-expected reading on consumer sentiment in January all injected life into US stocks on Friday."
Add to that Friday's news of Ben Bernanke's confirmation for the second term as the Fed chairman, and you've got a bullish "perfect storm": A slew of strong economic data plus "reduced uncertainty" all lifted stocks higher.
But then things began to fall apart. Around noon, the Dow erased the gains and slipped below the prior day's close. The headlines changed the tune: "Don't Rejoice Over Higher GDP Yet," said one, because, "...even as Wall Street rallied on the news there are plenty of warning signs of a slower pace ahead." The DJIA closed on Friday with a loss. "US Stocks Drop as Concern Over Technology Earnings Overshadows GDP Data," a major news source summarized the day.
You see what happened: Throughout the day, investors and analysts simply focused on the news stories that best fit that hour in the market. Had the Dow closed higher on Friday, do you think anyone would have even mentioned "tech sector weakness"?
This seems like a flawed approach. First, there is obviously little objectivity in assigning news to market action. Second, you're almost always one step behind, explaining moves that already happened. And third, even if your explanation "fits," it offers no predictive value. Here's what I mean: Next time we see a jump in the GDP, business activity and consumer confidence, is that bullish or bearish?
You may say, So what? Investors had a change of heart midstream. Exactly. The Dow's behavior on January 29 is a good example of how it's not facts, but investors' collective emotions that rule the trend. Investors buy and sell based on how they feel. As for news, they only choose the stories that help them rationalize their trading decisions. Bullish investors disregard "tech sector weakness" and buy. Bearish investors disregard "strong GDP" and sell. So the real question is, How do you know what mood is the crowd in?
The Elliott Wave Principle can help you answer that. It shows you that investors herd, in a way that's irrational and impulsive. Yet it's not random: Investor's collective emotions shift in patterns. (Sorry, "random walk" fans.) Once you know which leg of the Elliott wave pattern your market is in, you can make a probabilistic forecast for the next move.
Elliott Wave International's publications can tell you now what Elliott wave patterns suggest for the markets. You can read our latest medium-term forecasts online today, risk-free: