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Looking at Economy to See Where Stocks Are Going? You Just Might Miss the Turn
"Stocks lead the economy, normally by months," says EWI's president Robert Prechter

By Vadim Pokhlebkin
Mon, 28 Feb 2011 15:45:00 ET
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Last week brought some troubling news about the U.S. economic growth: 

Fourth-quarter growth revised down to 2.8%
MarketWatch, Feb. 25 -- The U.S. economy grew at 2.8% pace in the final three months of 2010 -- slower than the government initially projected... Despite the downward revision, U.S. stock prices mostly rose...
 
Notice that last sentence: "Despite the downward revision, U.S. stock prices mostly rose." The belief that the GDP and other economic measures drive stock market trends is alive and well.
 
The reality is that "stocks lead the economy, normally by months." EWI's president Robert Prechter has studied this subject in depth. Here's an excerpt from his June 2008 Elliott Wave Theorist, written shortly before the DJIA went into the most violent part of the 2007-2009 crash.
 
The economy lags the stock market because the stock market reacts instantly to changes in society’s mood, whereas it takes time for employers and corporate CEOs to make decisions based on those changes. Wave (1) down in stock prices ended in March [2008; see chart below], and only now are we receiving the economic reports that resulted from that mild move toward more negative social mood.
 
 
I love the way the worst economic news tends to coincide with bottoms and rallies in the market, confusing everybody. As the market rallied in wave (2), much of the economic change prompted by the decline in mood during wave (1) took place. The jump in the unemployment rate in May [2008] was the largest in 22 years, and the number of unemployed is now the highest since the end of the 1974-1975 recession.
 
But look: This is the result only of a measly wave (1). When waves (3) and (5) take place, the economic results will be far more devastating.
 

Latest from Prechter: The expanded, 12-page February Elliott Wave Theorist answers the question, "Are we in a new bull market?" Read it online now, risk-free.

 
Prechter was right. By March 2009, when the DJIA had crashed below 6,500 and the anticipated waves (3) and (5) unfolded (see the chart), unemployment did spike much higher. Ironically, investors who got panicked by high unemployment, poor earnings, record-low consumer confidence and other bad "fundamentals" at the time were surprised by the DJIA rally that followed.
 
By conventional logic, you'd have to agree that it was "bad economy" which produced the biggest rally in 70 years off the 2009 low. But here's an explanation that actually makes sense: Broad market trends are not created by the economic conditions. The Elliott wave model explains that social mood sets trends in stocks, and it doesn't depend on the latest GDP number, or what Ben Bernanke had for breakfast -- the mood changes for endogenous reasons. Those changes follow Elliott wave patterns, making the stock market probabilistically predictable.
 
In other words, nothing tells you better where the stock market is going next than the stock market itself.
 
Don't wait for the economic news to catch up with stocks -- by then, it may be too late to act. Find out what Elliott wave patterns suggest for the next move in stocks right now with Prechter's latest Theorist.

 

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