At EWI's Message Board, we receive great questions from subscribers and free Club EWI members daily. Here's one that deserves an expanded answer:
"Can you please explain what you mean by the phrase, 'The news doesn't make the market, rather the market makes the news'?"
Another way of putting this would be: It's not the news that creates trends in the financial markets. For example, people who believed the news stories about "Goldilocks economy" in early 2007 were caught by surprise later that year, when stocks began their worst losing streak in almost 80 years. Conversely, investors who focused on the terrible economic news in late 2008 got their surprise when the DJIA bottomed in March 2009 -- against the grim background of high unemployment, poor earnings, record-low consumer confidence and other bad "fundamentals."
In both cases, the news didn't "make the market" -- in fact, if anything, the news suggested that the current trends would continue. But they didn't: In both cases, stocks reversed before the news gave them a "reason" to. And it was the news that had to play catch-up with the new trend in stocks.
"'The news doesn't make the market" is a radically different concept than the conventional assumptions about how the financial world works. EWI's president Robert Prechter pioneered the very idea that the news is irrelevant to markets, and has written extensively about it; he calls it "socionomics."
Here's an essay by Prechter on the topic. This is an excerpt from his May 2009 Elliott Wave Theorist, "Market Musings."
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Irony and Paradox
By Robert Prechter
To anyone not versed in socionomics, everything the stock market does is saturated with paradox.
-- When T-bills sported double-digit interest rates in 1979-1984, investors saw no reason to abandon their T-bills for stocks; when T-bill rates were low in the 2000s, investors saw no reason to put up with the “low yield” of T-bills and sought capital gains in stocks. The first period was the greatest stock-buying opportunity in two generations, and the second period was the greatest stock-selling opportunity ever.
-- When long-term bonds yielded 15 percent in 1981, investors were afraid of Treasury bonds even though they were about to embark on the greatest bull market ever; in December 2008, when the Fed pledged to buy T-bonds, rising prices appeared so strongly guaranteed that the Daily Sentiment Index indicated a record 99 percent bulls, just before prices started to fall.
-- When oil was $10.35 a barrel in 1998, no one made a case that the world was running out of black gold; but when it was 7-8 times more expensive, some three dozen books came out arguing that global oil production had peaked, a theme that convinced investors to begin buying oil futures…about a year before the price collapsed 78 percent.
-- In the second half of the 1990s, the idea that stocks would always be the best investment “in the long run” became popular just as a long period of superior returns was coming to an ignoble end. A new study...shows that as of today the S&P has underperformed safe, boring Treasury bonds for the past 40 years, since 1969.
-- Just when nearly everyone -- including world-famous investors -- finally panicked and conceded in February-March 2009 that the financial and economic worlds were in dire shape, the market turned around and shot upward in its fastest rally in 76 years.
And so on. The exogenous-cause [i.e., news-driven -- Ed.] model fools investors exquisitely. One reason is that rationalization follows upon mood change. Mood change comes first, and attempts at reasoning come afterward. Financial markets express moods immediately, but reasoning lags, and by the time investors adopt compelling convictions, social mood is ready to charge in the other direction.
Another reason is that social actions follow upon mood change, because they are results, not causes. Social events then provide a basis for rationalization about the stock market. All thinking that attends these events derives from mood changes that have occurred in the past and proceeds without a clue as to mood changes that lie directly ahead. Paradox after paradox results.
Socionomists recognize that social mood is primary and has consequences in social action, so we never have to wrestle with paradox. To us, the markets’ pervasive irony is completely normal, somewhat predictable and wonderfully entertaining.
To succeed in the market, you must learn initially to embrace irony and paradox, at least as humans are unconsciously wired to interpret things. Once you get used to the world of socionomic causality, the irony and paradox melt away, and everything makes perfect sense.
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