The Plunging Economy Vs. The Stock Market Rally
Stock-Markets / Financial Markets 2009 Jun 15, 2009 - 07:49 AMBy: Uncommon_Wisdom
Larry Edelson writes: If you’re like the average investor, you’re probably wondering how can stocks rally when the economy continues to sink?
How, too, can commodities — especially oil — surge when unemployment continues to rise and businesses are shutting their doors left and right?
I consider the answer to both of these questions one of the most valuable lessons you can understand about the markets.
After I explain the answer, I’ll then respond to some of the most popular questions I’ve been receiving lately. And to wrap up this week’s column, I’ll give you a quick update on what I’m seeing in the markets.
Now, the sooner you understand the answer to the two foregoing questions, the more money you’ll make in your investments.
The Economy And The Markets Are Often Two Different Animals
Huh, you’re asking? What’s Larry talking about?
Let me explain — and be sure to keep your thinking cap on!
First, the economy. Suppose you’re in the market to buy a new appliance, say an LCD TV, a washing machine, or a car. Aside from the different makes, models and features, what are the most important factors that influence your decision on what to buy?
If you’re like most people, there are three factors …
1. Your budget.
2. The perceived quality of the brand name of the product. And …
3. The best price at which you can purchase the item.
Put another way, once you’ve decided on your budget and the brand name of the item you want to purchase, your chief objective is to shop around and get the best price possible.
Now, compare that to the markets, be it stocks, bonds, or commodities.
Sure, like everyone else, you want to buy low with the aim of selling higher.
BUT, you never really know what a “low” price is for a particular investment. Nor do you know what a “high” price is, at which you will sell that investment.
Furthermore, when you’re buying a particular investment, so are tens of thousands, even millions of other investors. So not only do you have competition, but you also have scores of other investors who have either a bullish or bearish sentiment about the investment you’re looking to buy.
Quite a bit different from buying a new LCD TV, a washing machine, or a car.
One is a personal choice; the latter, the investment, a public choice dictated by the herds of investors you’re a party to when buying investments.
Notice that word “herd.” Because once you understand its implications, you’ll see the markets in an entirely new way.
Now listen carefully: With very few exceptions, like say when the Apple iPhone debuted, the economy is not impacted as much by “herding” behavior as the markets are.
Sure, if everyone you talk to says the economy is lousy and your friends are losing their jobs left and right, you might delay the purchase of a new LCD TV out of fear of bad times ahead.
But if the price of a stock you own or are eyeing to buy is soaring, you are far more likely to jump into the market and buy it, or buy more of it, than you are to put it off like the purchase of a new LCD TV.
The chief reason: The herding behavior of investors in markets. Investors move in herds, as giant pools of capital that have an almost inexplicable, unconscious power over your thoughts and feelings … and that can often be very misleading.
Proof: Despite always aiming to buy low and sell high, more than 90 percent of investors actually buy their investments near the highs and sell near panic lows.
The end result: Most investors lose money better than 90 percent of the time.
Go back to the LCD TV for a moment. You found the best deal and buy the TV. You don’t really care whether its price falls a bit or even goes up. You got yourself a good deal and a new LCD TV.
Bottom line: Markets operate on the “herding principal.” A very deep and powerful psychology that is nowhere near as present as it is in the day-to-day affairs of the economy.
And therein lies the difference. The reason why at times the markets can soar even while the economy looks lousy.
Eventually, when the economy and the markets (herds of investors) wake up to the gap, the disparity is almost always corrected. Either the economy rises to reflect the optimism in the markets, or the markets collapse to reflect the still negative sentiment in the economy.
The most important point is that there are frequent periods in the markets when they act and behave in total contradiction with the economy. And once you recognize that, you can anticipate “herding behavior” all the better, and start making more money, no matter what the markets or the economy are doing.
Now, I’m sure you’re asking: Is there a way to measure “herding behavior?”
Yes, there are several ways. There are technical indicators analysts use such as bullish and bearish sentiment figures, surveys of representative numbers of investors, defining the numbers of bulls versus bears on a percentage basis.
And there are a host of other indicators, such as “relative strength,” which measure the strength or weakness of the price trend of an investment relative to other investments, or even to itself.
But in my opinion, in 31 years of experience with technical indicators, there is none better than “cycle analysis” — the science of studying herding behavior in the markets to uncover the hidden psychological forces that drive investors to move in groups.
I’ve studied market cycles all my life. And cyclical analysis is my chief timing tool. There is no better way to time investments than cyclical analysis. It identifies herding behavior.
And it can help you make serious money in the markets, especially when what’s happening in the markets is in contradiction with what the economy, the news, the media (and most other analysts) are telling you.
I’ve been giving you a glimpse of my cycle analysis in previous columns. It helped me identify for you the March low in stocks, and make investment suggestions that now show open gains of as much as 44.9 percent — while almost all other investors and analysts are still wondering how the markets could rally when the economy still looks so bad.
My recommendation when it comes to investing: Keep the economy and the markets separated in your mind. They are not always synonymous.
Now, on to some of the most popular questions I’ve been receiving lately …
Your Questions and My Best Answers
I’ve received quite a few questions from readers and the media regarding my views on natural resources, especially gold. So I thought now would be a good time to answer them for you.
Q: Larry, why should I invest my money in gold now? After all, it’s almost quadrupled since its 2001 lows.
A: Simple: Because governments around the world are fighting “cyclical forces” they cannot win, governments are going broke. Paper currencies are losing purchasing power, especially the U.S. dollar, and investors around the world are losing faith in their elected leaders.
Gold is the ideal hedge against government instability. Period. So I believe everyone should own gold, regardless of its current price.
Q: What do you think of the recent talk from the International Monetary Fund (IMF) about selling gold?
A: Let ‘em! Savvy investors will buy up every ounce the IMF sells. So will smart central banks in countries such as Russia, China, India, Saudi Arabia and other OPEC nations.
Also keep in mind: Historically, when central banks and other official institutions have sold gold, it’s almost always been bullish for gold’s price.
Consider the late 1970s when the U.S. Treasury sold tons of gold. Traders and savvy investors bought every ounce at every auction, and more. And despite the Treasury sales, gold prices went up, up, and away!
Q: What do you think of rare coins? I’m getting a lot of pitches on them.
A: Very risky! Unless you have a dealer you trust and who knows the market inside and out, I’d steer clear of them.
Q: My stock broker tells me I’m crazy to buy gold shares right now. What do you think?
A: Like gold itself, I’d buy gold shares on the dips. Owning gold shares, in addition to the yellow metal itself, is a no-brainer in my opinion. They’re leveraged to the price of gold. So as gold heads higher longer-term, gold shares should do extremely well.
Speaking of which, gold is now preparing for its next leg up. We may see one more dip, but as soon as gold closes above the $1,007 level, I expect its next stop to be at least $1,250.
Q: You’re still bullish on China and Asia. Why? Don’t you think they’re headed for tough times?
A: Growing pains? Yes. Truly tough times? No.
There are 3 billion people in all of Asia that are determined to improve their lifestyles. That’s going to make for economic growth that will outperform the Western world for many more years.
As for China, someday in the future, a rebellion against Beijing is possible. It’s pretty darn hard to usher 1.3 billion people into capitalism without it because the growing gaps between the rich, the middle class, and the poor will ultimately become an issue. But I think that’s still years away and there’s a lot of economic growth that will take place between now and then.
Also note: Once again, China’s economy is outperforming most analyst forecasts …
May automobile sales smashed expectations, soaring 47 percent over last year, the most since February 2006
Second quarter GDP is on track to hit at least 8 percent, beating estimates hands down
Retail sales, property sales, capital investment, loan growth, and more are all rising rapidly, indicating the economy is about to boom again
And the Shanghai Composite is now up 68 percent from its November low!
Meanwhile, the Dow Jones Industrials, S&P 500, Nasdaq, and other Asian markets are also firmly on track with my recent forecasts. I expect stock markets to move higher into the latter part of this month, with the potential for the rally to extend into late August.
Bottom line: Hold all positions I’ve suggested in my columns!
Best wishes,
Larry Edelson
P.S. Be sure to become a member of Real Wealth Report, my monthly publication which gives subscribers a more detailed analysis of the markets and more precisely timed buy and sell signals. This month’s issue — “Why the Dollar Is Doomed” — publishes on June 19. You won’t want to miss it.
To pick up a one year subscription for just $99, click here now.
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