There are no great mysteries as to why markets rise and fall over the long term. A simple view of markets is that all human activity and responses are synchronized over the longer term. See the 2 charts below. Human economic activity is measured by Gross Domestic Product, Industrial Production and measures like Non-Farm Employment and the Chemical Activity Barometer. What investors are willing to pay for perceived return is in the eyes of beholders. Value Investors are responsible for major market lows while market tops come from the activity of speculators and Momentum Traders. The fact that there are 100’s of thousands more speculators and traders than there are Value Investors telling us what we should be doing, in effect telling us to trade with them throughout the day, makes it very difficult to winnow the wheat from the chaff. Most investors fail to take a much slower, much more measured approach towards investing for their futures. The chart below shows the long running Chemical Activity Barometer(CAB) vs. Industrial Production(IP)&Non-Farm Employment(Emp) from 1990 thru today’s June 2014 report of 96.9. CAB leads IP and Emp as a measure of economic activity, by up to 9mos vs. IP and by up to 12mos for Emp.
Economic data: CAB vs. S&P 500
This chart shows the CAB vs. SPDR S&P 500 ETF Trust (NYSEARCA:SPY). It should be quite convincing. Equity markets, as represented by the S&P 500, rise and fall in response to economic activity AFTER and NOT in anticipation of increased economic activity.
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What I am saying is that one can clearly see that investment activity is stimulated (market psychology is shifted) by economic activity. In short: markets are led by economics! It is not the other way around as we are so often told by various prognosticators in the media. The periodic ebbs and flows of investor psychology as the economy progresses is always someone’s concern that it will impact the economy, but this has never occurred. Investors with a longer term perspective understand this. Economic activity is always slow to turn mainly because it involves over 310million of us working to sustain our livelihoods in unison. Once the economy has established a trend, it has almost always continued thru its cycle low-to-high-to low in a way one can understand. The only 2 instances in which a decent economic trend was stalled occurred in 1937 when government suddenly raised rates and taxes as a punishment to the wealthy and then again in 1982 when Paul Volcker moved to stem the early 1980’s inflation psychology mania. Once one sees a major economic bottom it can take multiple months before investment markets respond. The investor whose focus is the economic cycle can invest and exit well before the bulk of investors have begun to realize changes in their own market psychology. Currently our economy is in a full uptrend with no near term end in sight. Historical analysis indicates we are likely to have 5yrs-7yrs of economic uptrend yet ahead. As the expansion becomes better appreciated, market psychology should turn more positive. Investors have always sold Fixed Income to favor Equities causing bond prices to fall as stocks rise as they turned more positive The history of investor behavior in chasing economic activity is why I have been and remain very positive on Equity markets and quite negative on Fixed Income markets. There is no way one can predict how high the SP500 can rise because the market highs are driven by market psychology and not by calculated reason. Our recent history suggests we could see the SP500 priced $3,500-$5,000+ before all is said and done in the current cycle. People like nice clean scenarios, specific dates and prices. Unfortunately markets are driven by psychology not by logic. While the major market lows are set by Value Investors, the tops are set by speculators and Momentum Traders.
Does The Market Or ‘React’ To Or ‘Anticipate’ Economic Data via ValuePlays