Stocks & Commodities V. 31:6 (38–41): News Events, Earnings, And Economic Numbers by Avi Gilburt

Stocks & Commodities V. 31:6 (38–41): News Events, Earnings, And Economic Numbers by Avi Gilburt
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News Events, Earnings, And Economic Numbers by Avi Gilburt

Leaders And Followers

News Events, Earnings, And Economic Numbers

The stock market is considered a leading indicator of economic trends. And yet traders rely on economic trends when it comes to placing trades. Which leads which? Here’s what you should focus on.

It's a commonly accepted principle that the stock market is the best leading indicator of future economic trends. Historically, every boom in the economy has been preceded by a boom in the stock market, and every downturn in the economy has been preceded by a downturn in the stock market. This highlights why economists have earned such a poor record at predicting the direction of the stock market, whereas an astute market observer can predict the direction of the economy. There’s a reason economics is known as the dismal science. A January 30, 2013 article on the Wall Street Journal blog titled “Why Did Economists Get GDP Wrong?” states that none of the 24 economists surveyed forecast a negative GDP for the fourth quarter of 2012. This is nothing new. In September 1996, an article in Business Week pointed out that “over the past 25 years, economic forecasters have missed four of the five past recessions.” A quote commonly attributed to economist John Kenneth Galbraith but which may have first been said by economist Ezra Solomon sums it up well: “The only function of economic forecasting is to make astrology look respectable.”

Common scene

If the stock market is the best leading indicator of economic trends, why do we see the same scenario play out time and time again? Here’s an example.

Say it’s 8:25 am on a Thursday, and many market participants are glued to their televisions watching CNBC or Bloomberg waiting, with bated breath, for the latest deluge of economic reports to be released. At 8:29 am, they have their finger on the trigger, expecting to make a trade based on the news releases. At 8:30 am, the numbers are released.The numbers aren’t positive and don’t point to economic growth. The investors’ initial reaction is that they will have to hit the sell button. But wait! The market is starting to move up, and it is even doing so explosively. How is that possible? The numbers were showing economic contraction, but the market is going up!

Here’s another scenario. How many of us have watched this scene play out when it comes to “Fed watching”? The common argument of Fed watchers is that when the Fed (US Federal Reserve) injects “money” into the system, the stock market goes up and the US dollar goes down. So why, at the announcement of Operation Twist in late 2011, did the stock market sell off? Well, the newshounds will tell us that it was not as much money injected into the system as the market wanted. But then why did the US dollar begin a strong rally right after that announcement following a protracted multiyear decline?

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