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Let's Be Reasonable About Financial Markets
Exogenous-cause reasons for market behavior are based on a false premise

By Bob Stokes
Tue, 30 Jul 2013 16:45:00 ET
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Brand Blanshard was a philosophy professor at Yale who believed that a life well-lived is based on being reasonable. 

At the age of 92, Blanshard expressed that belief in his book, Four Reasonable Men: Marcus Aurelius, John Stuart Mill, Ernest Renan, Henry Sidgwick. The book's focus is on the lives of the men, instead of their philosophies.
 
Blanshard lived to be 95. Here's a quote from his obituary in The New York Times (1987):
 
He espoused rationalist thought and wrote a trilogy on reason. ''What is reasonable is right,'' he said in an interview in 1977. ''How many people have succeeded in being reasonable for a day, a week, a life?''
 
Of course, "reasonable" means being fair, thoughtful, open-minded, etc. We've all heard the phrase, "Let's be reasonable," spoken as a request for people to tame their emotions and reach a satisfactory outcome.
 
Yes, we're all also aware that things don't always work out that way. Bias and emotion at the unconscious level often block the path of reason. The "logic" we have for a course of action is too often a rationalization for what we want.
 
That's certainly the case in financial markets, where emotion rules. When the prevailing sentiment is bullish, investors find endless "reasons" for why stocks will continue to rise. When sentiment is bearish, investors never run out of reasons to support their bearish view.
 
For example, pundits may say stocks are going higher because equities are undervalued. But those same pundits were silent about the market's valuation around the time of the previous major low, when stocks were even cheaper. In a downtrend, pundits might point to slow economic growth to justify a bearish view even though they ignored equally poor economic indicators during the prior rally.
 
The truth is: All exogenous-cause market reasoning is based on a false assumption. But, investors and the financial media continue to hold that assumption nearly every day.
 
But get this:
 
In their 1989 paper, Cutler, Poterba and Summers investigated ... days during which stock prices moved dramatically, they scoured the news to find exogenous causes. Their conclusion is stunning: '…many of the largest market movements in recent years have occurred on days when there were no major news events.'
 
In other words, whenever the stock market was leaping or plummeting on any particular day, there was often no news sufficiently striking to explain it.
 
The Elliott Wave Theorist, March 2010
 
If exogenous causality does not determine stock market prices, what does? The answer is the collective psychology of investors. That's where an investigation into the cause of market behavior should start.
 
Investor psychology unfolds in repeated patterns, regardless of the nature or scope of events exogenous to the market.
 
The Elliott wave method of market analysis is based on the patterns of investor psychology. That does not mean that a given interpretation of the market's pattern at a given time will always prove correct. But it does mean that an analyst is starting from the correct assumption, and through persistent work will likely see when the pattern comes into clear view. But market forecasts based on exogenous causality will never uncover why a market forecast turned out right or wrong.
 
The market has trended upward for over four years now. EWI's publications see a pattern in market prices that should be of interest to every investor.
 

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