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Improving Economy is Bullish for Stocks. Right?

Yes, it’s a trick question. Read on to understand why.

by Vadim Pokhlebkin
Updated: February 03, 2014

To decipher the meaning of economic reports like this is bread and butter of fundamental analysis. Positive data are said to be bullish for the stock market, while negative economic reports are bearish. But is this accurate?

What a strange question, you may say -- of course it is! Stocks don't fall after good reports, or rise after bad they?

Well, please take a look at these financial news headlines -- and guess when they published: 

  • Fed chief predicts economy will rebound despite housing woes (AP)
  • IMF predicts an energetic world economy (
  • Job Growth Strengthens Economy (Washington Post)
  • Several Signs the Economy Is Reviving (New York Times) 

Did they publish this week? Last week? Last month?

No. They all published in April-July of 2007 -- yes, right before the 2007-2009 global financial crisis crushed the world markets.

This DJIA chart (courtesy Bloomberg) makes it clear just how mismatched the mainstream expectations were with reality: 

DJIA chart (courtesy Bloomberg)

Hang on -- now read these news items and guess when they appeared (bold added): 

  • S&P 500 is at risk of hitting a new low as angst persists (USA Today)
  • VIX Premium Shows Stocks Bear Market Lasting 2 Years (Bloomberg)
  • Why Stocks Still Aren't Cheap (New York Times)
  • "February's consumer confidence numbers were the lowest on record, going back to 1967. ...there can be no market turnaround until the consumer is confident once again" (Forbes) 

Perhaps this was an easier guess: February and March 2009, at the end of the graph above -- and the end of the collapse in stocks. That's when the DJIA fell as low as 6500, and when the fundamentals were at their worst in decades. And yet the stock market was about to begin a huge rally.

How can this be? Shouldn't it work the opposite way?

In theory, yes. In reality -- the lesson is obvious: The apparent strength or weakness of the economy does not lead the stock market higher or lower. It's the other way around:

"Stocks lead the economy, normally by months."

That's a quote from one of the essays by EWI president, Robert Prechter, who researched this subject in-depth. (He also called for a "sharp" rally in stocks in late February 2009 -- despite the uber-bearish fundamentals at the time.) 

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