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February 19, 2008

Do Markets Make News or Does News Make Markets?
by Michael Swanson

Last week I went out of town to the Cambridge House Resource Investment Conference in Phoenix, Arizona. They had about 1,500 attendees, which is about half of the number they get in Toronto and Vancouver. There were about half of the booths there too. The tone of the conference was decidedly negative when it came to the US stock market and even to metals stocks too.

Most investors I talked too were nervously holding their mining stocks. I listened to the two main speakers panels on the first day of the conference and just about all of them appeared to expect some additional selling in gold stocks to take place. The moderator of the panel asked all of the speakers if they still thought mining stocks were worth owning with the stock market in a bear market. One person responded by saying that he buys mining stocks that he expects will make good discoveries that will eventually cause their stock price to go up. If the market makes them drop for now they'll eventually go up later. A lady on the panel said she had put all of her money into treasury bills and expects to keep it their for two more years.

Everyone seemed to agree that the stock market is dangerous right now and the consensus was just the same on the second panel. A lot of people claimed that the US banking system is totally bankrupt and could cause a market crash at any moment. Paul Van Eden talked about deflation.

Everywhere you look the news is bad. Economic numbers are negative, earnings are bad, and rumors of bank failures are everywhere. Investors who have been holding on to gold stocks for the past four weeks and have seen them trade sideways have become anxious while CNBC fund managers talk of the market breaking its January lows if bond insurers don't get a bailout.

It is hard to find anyone who thinks the market is going to go higher from here and it is hard to think of a time in which everyone is so negative on the stock market. Since the sharp drop in January the market has basically traded in a range and gone nowhere. During this time people have gotten increasingly anxious and negative.

Of course from a contrarian stand point this is exactly when you want to buy. The crowd tends to be wrong at market tops and market bottoms. At the October top over 60% of the people who respond to the Investors Intelligence survey were calling themselves bulls. Last week that number dropped all of the way down to 36.7% while the number of bears rose to 35.6%. This is the fewest number of people calling themselves bulls seen since the end of the last bear market in July of 2002. There are even few people calling themselves bulls now than there were at the last major bottom in August of last year while the bulls minus bears spread is at a level not seen in over two years.

It is not a good idea to ignore the Investors Intelligence survey. There has never been a major market drop in the months following readings like this.

In fact these readings actually make me more bullish on the stock market than I was a week ago. Up until then I was expecting a rally that would last 6-8 weeks and take the broad market averages up to their 150 and 200 day moving averages. After that I expected them to top out and go through another bear decline. These readings are so bullish though that I have to consider the possibility that the market will rally longer and further than I have been expecting.

I don't know that for sure, but what I do know is that the market is likely to rally so much that it will take just about everyone by surprise. Everyone is talking about bear markets and focusing on bad news, but news doesn't make markets. Markets make news. In reality people base their investment decisions on their emotions. They choose to buy or sell on how their positions are acting and how that makes them feel. Falling stocks make people negative just as a long rally makes people bullish and helpful. People sell when stocks drop and get negative and buy in at the top. That's why the crowd is almost always wrong at important market turning points and why it pays to bet against them.

In volatile markets like this you must pay attention to investment psychology and learn to buy bottoms and sell near tops to make money. We are not in bull market that is going to allow you to just buy and automatically sell later. Nor are we in a market where you can just buy or sell based on how pessimistic or optimistic people on TV are and how the news makes you feel. That is a guaranteed recipe to lose money. Instead you are going to have to watch the chart patterns in the market and keep a close eye on sentiment indicators such as the Investors Intelligence Survey and the VIX. You will have to remember that news doesn't make markets. Markets make news. And that means you'll have to understand how markets work to be one of the winners this year. This is not going to be a year of the crowd.

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Michael Swanson,
WallStreetWindow.com

Disclaimer: Michael Swanson is the President of USA Capital, Inc., which provides management, support, and research for institutional investors, hedge funds, and mutual funds. The ChartWizard is also an employee of USA, Capital, Inc. Both Swanson and employees and associates of USA Capital, Inc. may have a position in securities which they mention on WallStreetWindow or any of its services. In such cases, appropriate disclosure is made. Under no circumstances should the information received from WallStreetWindow represent a recommendation to buy, sell, or hold any security. WallStreetWindow contains the opinions of Swanson and the ChartWizard and is provided for informational purposes only. Neither Swanson, the ChartWizard, nor TimingWallstreet, Inc., which owns WallStreetWindow, provide individual investment advice and will not advise you personally concerning the nature, potential, value, or of any particular stock or investment strategy. To the extent that any of the information contained on WallSteetWindow may be deemed investment advice, such information is impersonal and not tailored to the investment needs of any specific person. Past results of WallStreetWindow, the ChartWizard, or Michael Swanson are not necessarily indicative of future performance.

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