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Robert Precther recently published a list of market myths for his subscribers which I’m sure he won’t mind if I review the lessons he voices in his article with you, borrowing from his excellent research to help make the arguments. Recognizing these market myths are critical to your success as an investor. Words: 1266
In further edited excerpts the original article* by the late Larry Edelson (www.uncommonwisdom.com) goes on to say:
So let’s get right to what I consider to be the top five market myths of all time!
Myth #1: Interest rates are the principal driver behind stock prices.
The argument:
Rising interest rates are bad for the stock market, and declining rates are good for stocks. Indeed, most stock brokers, and the majority of analysts and newsletter editors, espouse the same causal relationship between interest rates and stock prices.
The facts:
There is no “standard relationship” between interest rates and stock prices. Period.
a) From March 2000 to October 2002, the Federal Funds rate declined from 5.85% to 1.75%, and the Nasdaq plunged 78%. Put simply, stocks and interest rates went down together!
b) From March 2003 to October 2007, the Federal Funds rate rose from 1.25% to 4.75% … and the Dow exploded higher by 74.2% In this case, stocks and interest rates went higher together!
c) From August 1929 to July 1932, the Fed’s discount rate fell from 6% to 2.5%, and the Dow industrials plunged a whopping 87%.
d) In Japan, from December 1989 to March 2003, the Bank of Japan’s discount rate fell from 4.25% all the way down to 0.10% – and Japan’s Nikkei 225 Index plunged from nearly 40,000 in 1989 to 7,824 in March 2003, a loss of 80%.
The fact of the matter is that, contrary to popular belief, there is no standard relationship between interest rates and stock prices. A little uncommon wisdom teaches you why. Just think about it for a moment …
a) When an economy is growing stock prices should do well. The demand for money and credit is increasing and so is the cost of money. As such, the two — interest rates and stock prices — should be rising together.
b) Conversely, when an economy is sliding, the cost of money is also falling, as demand for credit contracts. Makes sense then that stock prices should also be weak, right along with the deflating cost of credit.
Right now almost everyone is telling you that if interest rates go up, that spells the death knell for stocks. Maybe so, but also, maybe not. I, for one, think that rising interest rates right now would be bullish for stocks because it would be symptomatic of demand coming back into the credit markets, of a heartbeat so to speak, and signs of life in the economy. Ergo, that would be a bullish sign for stocks.
Myth #2: Rising oil and energy prices are bearish for stocks.
The argument:
Increasing cost of energy is a tax on consumers and squeezes corporate profits as well. Therefore, rising energy prices are bearish for stocks.
The facts:
Not so! There is no consistent relationship between energy prices and stock prices. Sometimes energy prices are rising along with stock prices, and sometimes they decline together. The relationship between energy prices and stock prices, if anything at all, historically tends to lean more towards a positive correlation. Like we’ve seen in the last year, for instance … The Dow is up dramatically from its low in March 2009 at 6,440. Simultaneously, the price of oil is up dramatically from $44.58 back on March 6th, 2009.
Strong demand for energy emanates from an economy that is either doing well, or, is recovering so shouldn’t that be a positive harbinger for stock prices? You bet it should. Another market myth exposed!
Myth #3: A widening trade deficit is bad for an economy, and conversely, a narrowing trade deficit is good.
The argument:
If a country is importing more than it’s exporting, hence, it’s shipping more capital offshore than it’s bringing onshore. Therefore, domestic stock prices must go down. Sounds reasonable, doesn’t it, but history proves that it is entirely wrong, and nothing more than a myth.
The facts:
a) From 1976 to 1998, the U.S. trade deficit ballooned from $6.08 billion to $166.14 billion, and guess what? The Dow Jones Industrials went from 848.63 to 9,343.64!
b) Since the Dow peaked in July 2007 at 14,239 the trade deficit has narrowed from a deficit of roughly $701 billion to $378 billion, or 46%!
In truth, the relationship between the trade deficit or surplus and stock prices is exactly the opposite of what the pundits claim. In other words, a rising trade deficit is related to rising stock prices, and a narrowing trade deficit with recessions and falling stock prices. It’s a myth that trade deficits are bearish for the stock market.
Myth #4: Corporate earnings drive stock prices.
The argument:
If a company’s earnings are rising, the company must be growing, therefore, its coffers must be filling up with cash to pay dividends, or acquire new products or other companies, and good times are here to stay so the company’s stock price must go up. Conversely, if earnings are falling, stock prices must go down.
The facts:
Have you ever seen a company announce better-than-expected earnings, and its share price gets clobbered? I’m sure you have, probably oodles of times. Conversely, you’ve also seen plenty of companies announce lower-than-expected earnings, and their share prices move up and the same thing can happen to the broad markets, taken as a whole. For example, 1973 to 1975: The combined earnings of the S&P 500 companies rose strongly for six consecutive quarters, yet the S&P 500 Index fell more than 24%.
Indeed, according to research conducted by analyst Paul Kedrosky, since 1960, the average annual return on the S&P 500 was greatest when earnings were falling at a clip of 10% or more while the smallest returns on the S&P 500 occurred when earnings were growing at up to 10% per annum.
Bottom line: Rising corporate earnings does not guarantee rising stock prices, by any means. Nor does falling corporate earnings guarantee falling stock prices! It’s wishful thinking to believe rising corporate earnings will lead to rising stock prices.
Myth #5: An economy’s GDP drives stock prices.
The argument:
Most investors and most analysts agree: Stock market prices as a whole, especially in terms of total market capitalization, should reflect a country’s gross domestic product (GDP), the sum total of a country’s overall economic output. Logical, right?
The facts:
a) From the quarter ending June 30, 1976 to the quarter ending March 31, 1980, GDP rose in 15 of 16 quarters yet the Dow Industrials fell 22%!
b) From April 1, 1980 to September 30, 1980, quarterly GDP contracted, yet the Dow Industrials rose almost 19%!
Direct positive relationship between GDP and broad stock market prices? There is none. Certainly none reliable enough to make investment timing decisions.
Conclusion
I have three bottom lines to the above five major market myths:
1. Never assume anything when it comes to the markets …
2. Question everything, and most of all …
3. Think independently, and exercise uncommon, not common, wisdom!
*http://www.uncommonwisdomdaily.com/5-major-market-myths-exposed-2-9016