Sentiment Speaks: The Market Does Not Like 'Build Back Better'

Let's all take a moment and be honest with ourselves right now. If the market had gapped up and rallied 50 points on Friday, what would the headlines in the financial news read?

"Market Rallied on Passage of Build Back Better"

Now, since the House passed the bill, and the market was flat on Friday, does it not then make sense to view the market as being unexcited by the Build Back Better bill?

Oh, wait. I am sure many of you are thinking it was "priced in." If so, please then point to me when the market rallied specifically to "price in" the passage of this bill before it passed? What, you can't do that? So, then how do you know it is "priced in?"

Another issue with this line of thinking is that if you believe that this was already priced in, then you must believe that the market is omniscient. I mean, the details of the bill were only completed not long before the bill was passed, so I am not sure how it could have been priced in unless the market was omniscient.

Are you seeing why this "priced in" perspective is simply poppycock?

Unfortunately, too many investors are too easily swayed by the news. Yet, how often does the news really drive the market? If you view it subjectively, you probably only remember the last time that a news event came out, and the market moved based upon that news event. But, I can assure you that were likely dozens of other times where the market either did not move or moved in the opposite direction you would have expected it to move based upon the substance of that news.

And, do you know how I am able to be so confident in my perspective? Well, because I based my perspective upon an objective understanding of the market rather than the subjective perspective held by most.

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 types 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 bearing on fundamental values explains only about one-fifth of the movement 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."

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.

So, what really drives markets? Well, we can look towards other research for that answer.

In 1997, the Europhysics Letters published a study conducted by Caldarelli, Marsili and Zhang, in which subjects simulated trading currencies, however, there were no exogenous factors that were involved in potentially affecting the trading pattern. Their specific goal was to observe financial market psychology "in the absence of external factors."

One of the noted findings was that the trading behavior of the participants was "very similar to that observed in the real economy," wherein the price distributions were based on Phi.

In a paper entitled "Large Financial Crashes," published in 1997 in Physica A., a publication of the European Physical Society, the authors present a new understanding as to what drives financial markets:

Stock markets are fascinating structures with analogies to what is arguably the most complex dynamical system found in natural sciences, i.e., the human mind. Instead of the usual interpretation of the Efficient Market Hypothesis in which traders extract and incorporate consciously (by their action) all information contained in market prices, we propose that the market as a whole can exhibit an "emergent" behavior not shared by any of its constituents. In other words, we have in mind the process of the emergence of intelligent behavior at a macroscopic scale that individuals at the microscopic scales have no idea of. This process has been discussed in biology for instance in the animal populations such as ant colonies or in connection with the emergence of consciousness.

As Bob Prechter has written:

This patterning of social mood creates a sociological imperative that mightily guides and influences the character of individual and social behavior. The resulting human actions, in turn, cause the trends and events of history. The overall process may be termed historical impulsion. As opposed to the traditional mechanistic models of aggregate behavior that are based upon presumptions of multiple exogenous causes and ultimate effects, socionomics recognizes that patterns of aggregate human behavior are endogenous, self-causing, self-regulating, self-reinforcing, and, to a far greater degree than has heretofore been imagined, predictable.

Based upon much recent research, it seems that, as a society, we are moved by our limbic system, which controls the impulsive actions of living creatures (including the "herding" impulse), and which will, subconsciously, often override the neocortex of our brain, which controls our reason. As Eric Hoffer aptly noted, "When people are free to do as they please, they usually imitate each other." Therefore, as a society, we seem to be hardwired so as to move in a unified direction, not affected by exogenous forces, as is commonly believed.

And, as Ralph Nelson Elliott noted decades ago:

The causes of these cyclical changes seem clearly to have their origin in the immutable natural law that governs all things, including the various moods of human behavior. Causes, therefore, tend to become relatively unimportant in the long-term progress of the cycle. This fundamental law cannot be subverted or set aside by statutes or restrictions. Current news and political developments are of only incidental importance, soon forgotten; their presumed influence on market trends is not as weighty as is commonly believed.

Therefore, what this leads us to conclude is that the substance of the news itself is not of great import. Rather, where we are in the sentiment trend is what will give the spin to the news event, and will direct the market. That is a much more reasonable explanation as to why markets go up on bad news and down on good news.

This also leads us to the conclusion that the market really did not care about the Build Back Better bill that was passed. And, I think Alan Greenspan told us just how much politics matters when it comes to the market:

[I]t hardly makes any difference who will be the next president. The world is governed by market forces.