Sentiment Speaks: 5 Reasons Why You Should Ignore All The Reasons The Market 'Should' Do Something

I love reading all the articles that give me reasons as to why the market should or should not do something. I am really amazed that there are so many people out there that still believe that the market moves based upon reason.

In fact, study after study has proven that markets are not driven by the substance of news or catalysts, as most believe. And, I have outlined a number of them in many past articles. Here are just a few.

In a 1988 study conducted by Cutler, Poterba, and Summers entitled “What Moves Stock Prices,” they reviewed stock market price action after major economic or other type of news (including major political events) in order to develop a model through which one would be able to predict market moves RETROSPECTIVELY. Yes, you heard me right. They were not even at the stage yet of developing a prospective prediction model.

However, the study concluded that “[m]acroeconomic news . . . explains only about one fifth of the movements in stock market prices.” In fact, they even noted that “many of the largest market movements in recent years have occurred on days when there were no major news events.” They also concluded that “[t]here is surprisingly small effect [from] big news [of] political developments . . . and international events.” They also suggest that:

“The relatively small market responses to such news, along with evidence that large market moves often occur on days without any identifiable major news releases casts doubt on the view that stock price movements are fully explicable by news. . . “

In August 1998, the Atlanta Journal-Constitution published an article by Tom Walker, who conducted his own study of 42 years’ worth of “surprise” news events and the stock market’s corresponding reactions. His conclusion, which will be surprising to most, was that it was exceptionally difficult to identify a connection between market trading and dramatic surprise news. Based upon Walker's study and conclusions, even if you had the news beforehand, you would still not be able to determine the direction of the market only based upon such news.

In 2008, another study was conducted, in which they reviewed more than 90,000 news items relevant to hundreds of stocks over a two-year period. They concluded that large movements in the stocks were NOT linked to any news items:

“Most such jumps weren’t directly associated with any news at all, and most news items didn’t cause any jumps.”

Yet, a commenter to one of the articles I recently read noted “[i]f we foresee catalysts, we'd all be billionaires.” And, nothing could be further from the truth. Consider how many times a catalyst was announced yet the market moved in the exact opposite direction than most expected based upon the substance of that catalyst. May I remind you of October 2022, at which time a worse than expected CPI report kicked off this 30%+ rally.

On Oct. 12, pundits were telling us that if the CPI report they expected to be published the morning of Oct. 13 was worse than expected, then we would see a 5% or worse decline in the market.

That same day, on Oct. 12, I posted the following analysis for the members of ElliottWaveTrader.net:

"Thus far, the market has made several attempts at hitting the blue box support region on the 60-minute SPX chart. And, each time, divergences continue to grow. And, if you look at the 5-minute SPX chart, there is still opportunity to actually strike that support below as long as we remain below the smaller degree resistance noted. . . But, I think we will likely be much higher than where we stand today as we look out towards the end of October, or even into early November, depending on how long it takes the market to bottom out, and how fast the rally I expect takes hold."

In fact, before the market opened on the Thursday morning of October 13, and as it was hovering near the lows of the month, I sent out an alert to our members at 8:56 a.m. noting my expectations for a bottom being struck and stated that "this should now be the selling climax that completes the downside structure." The market bottomed within half an hour of my alert and rallied 6% off the morning low.

Later that day, I saw quite a few comments on Seeking Alpha which outlined the common confusion of market participants at the time:

"Am I the only one wondering what the heck is going on with this market? I feel like it makes no sense anymore.. Today made NO sense."

In fact, in a Barron's article later that day, the author outlined the common feeling in the market that day:

"It was a massive rally, and one that came out of nowhere. And it's left market observers like yours truly wondering what the heck just happened. There wasn't any new data, no headline-making speeches, no event that occurred just after the open to spur such a move. It literally came out of nowhere-and left us grasping for possible reasons. "Today's market reversal was a head-scratcher," writes Oanda's Edward Moya. And he's not wrong."

Yet, the members of ElliottWaveTrader were certainly ready for that rally:

"...today was like EW proof on steroids. Had an up 8% portfolio run - including selling shorts at the bottom and immediately loading up on the turn. Without this service I would never have been poised to jump that quick. The confidence of recent updates was pretty overwhelming."

"Just want to say that was an amazing call this morning.. I have been a member for about eight months. Definitely an Elliott Wave neophyte, but lots of trading experience. just amazed. I be 62, old dawg.”

Another glaring example I can highlight is what happened when Russia invaded Ukraine. Back in April, I presented a keynote address at the MoneyShow in Las Vegas. During the question and answer segment of the presentation, an older gentleman asked me a question as to whether I believed that the cessation of fighting in Ukraine would cause the market to rally. Being trained in law school, I answered his question with my own question. I asked him if he knew what happened to the market the day that Russia invaded Ukraine? Of course, he confidently responded that the market went down. You should have seen the shock on his face when I told him that the market began a 10% rally on the exact day that Russia invaded Ukraine.

As I have said many times, external events affect the markets only insofar as they are interpreted by the market participants. Yet, such interpretation has been guided by the prevalent social mood. Therefore, the important factor to understand is not the social event itself, but, rather, the underlying social mood which will provide the “spin” to an understanding of that external event.

To put it most simply, the market tops when the general sentiment of the market reaches a bullish extreme, and it bottoms when the general sentiment of the market reaches a bearish extreme. Moreover, good news is disregarded during negative/bearish sentiment trends and bad news is disregarded during positive/bullish sentiment trends. So, understanding where we are in the general sentiment trend is the key to interpreting these news events, as well as being able to glean a better understanding of market direction.

During his tenure as chairman of the Federal Reserve, Alan Greenspan testified many times before various committees of Congress. In front of the Joint Economic Committee, Green- span noted that markets are driven by “human psychology” and “waves of optimism and pessimism.” As Alan Greenspan also noted, “[t]he cause of economic despair, however, is human nature’s propensity to sway from fear to euphoria and back.” He also recognized that “[i]t's only when the markets are perceived to have exhausted themselves on the downside that they turn.”

In other words, Greenspan correctly recognized that it is sentiment that drives the market. He even went so far as saying that “[r]egulation, the alleged effective solution to today’s crisis, has never been able to eliminate history’s crises.”

So, forgive me if I discount all these articles which claim that one should be investing in the market based upon one reason or another. Markets are not reasonable environments. Rather, they are emotional environments. As I have said many times, how well does it work for you when you argue logic and reason to your spouse when they are emotional? In fact, has that EVER worked?

To this end, we utilize an analysis methodology that tracks market sentiment based upon Fibonacci mathematics. And, this assists us in identifying points of trend change.

As far as where we stand right now in the market, I can only provide a simple perspective publicly this week, as it would be a bit too complex and lengthy to explain the details that I have provided to the members of ElliottWaveTrader over the weekend.

Since we caught the low in October of 2022, we have caught most of the twists and turns in the market, as our members have noted:

“I echo the amazement at the reliability of fibs, and in particular Avi and Mike's blue boxes. You guys have been playing these twists and turns like a fiddle.”

And, we have been expecting the market to provide us with a topping structure of late. Thus far, we have seen enough action to make it much less likely that the market is going to attempt another rally in the very near term to higher highs. So, we have moved into the phase of assessing whether the market is dropping in a corrective or impulsive manner. And, if you remember from my prior articles, if we pullback in a corrective manner, then we will need to prepare for a rally to 4800SPX next. However, if the market drops in a clearly impulsive manner, then we have likely struck a top which can hold for many years to come, as we prepare for the resumption of a bear market.

But, it will likely take us several more weeks to make the determination as to whether the market is simply providing us with a larger corrective pullback before we head to 4800SPX, or if we have struck a major top and setting up to break down the October 2022 lows. Unfortunately, it will take a bit more patience until the market makes that abundantly clear so we can appropriately deploy cash in order to join the next multi-hundred point trending move. It is for that signal that I am eagerly seeking over the coming two or three weeks.

In the meantime, large degree support in the market resides in the 4270-4350SPX region, and I am expecting a test of that support in the coming weeks.