A random walk of sentiment

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Reading Time: 4 minutes

Published: April 30, 2009

So what moves the markets: information or sentiment? Data or mood?

There are some who think it’s pretty much 100 percent new information, and some who think it’s 100 percent sentiment. With most analysts probably sitting somewhere along that very wide spectrum.

The markets this week are an interesting case study of this basic question. In the wake of the news about swine flu becoming a considerable worldwide threat, there’s been lots of market action. On Monday, after the weekend announcements, lean hog futures in Chicago tumbled and went limit-down. And the world’s stock markets looked awfully shaky early week, threatening a more than month-long rally, as airline shares and food company values plummeted.

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That seemed a pretty darned clear reaction to the new information about swine flu that poured into the markets over the weekend.

And the lean hog futures seem to be still (in)digesting that information, because they continue to plunge off the cliff, like a waterfall. (Go check out the May Lean Hogs futures chart at www.cme.com)

But a funny thing has happened in the stock markets: they’re up. The rally continues. The World Health Organization has upped the alert to its most extreme measure of expectation for a pandemic to occur, and the markets are rising. Nothing could derail the rally’s optimism, at least not so far, it seems.

The markets are full of information every day, hence the enormous difficulty in figuring out what’s actually moving them. They daily offer handy excuses for traders and investors and journalists to explain why the market moved the way it did today, but whether those excuses are more than excuses is often impossible to tell. Why has the market moved up so much yesterday, overnight and today so far? Well, according to the heads on Bloomberg TV that were chattering away at two a.m. when I got up to let the dogs out and change a diaper (not mine), it’s because corporate quarterly earnings are generally better than analysts expected, and no one but Mexicans are dying of swine flu so far. So worries about recession and the Black Death are declining, they said.

Funny isn’t it, how backward looking data like last quarter’s results and leaped-to conclusions about the possible lethality of a rapidly evolving pandemic can be apparently solid reasons for the markets to continue rallying. Why was the WHO upgrade of the pandemic rating -finding the disease has set up shop within domestic populations of a number of countries – not much of a market mover? Apparently the no-one-but-Mexicans death toll. 

This is the kind of weird market action that provides comfort to many technical analysts, especially those who rely on market sentiment indicators for their price analysis. They see it as a clearly smoking gun that proves that “information” doesn’t move the markets, but that sentiment in the markets drags out whatever information it wants to believe in. The pandemic is spreading and has definitely gone worldwide? Who cares? Only Mexicans are dying! We’re all safe!

Typical of the thinking of sentiment-reliant analysts – although much more advanced than most – is that of Elliott Wave International. In a note a couple of days ago it highlighted the swine flu’s interaction with the continuing market rally, noting that not only was the market impervious to the disease’s sudden newsworthiness this week, but that it has been floating around the edge of the news for weeks. Here’s what they said:

“One problem: the feral virus has been a smoldering topic in the news for quite some time now. The first official mention of the swine flu outbreak occurred on April 6, when local health officials in La Gloria, Veracruz, Mexico reported that 60 percent of the town’s population was infected . . . Moving right along, on April 17 the Centre for Disease Control and Prevention reported the first case of swine flu in the United States with two infected children in southern California. Then on April 21 the CDC announced that “human to human transmission of this new influenza virus has occurred.” Soon after the words “Pandemic,” “Panic,” and “Plague” rapidly appeared on the world wide webosphere.

“Yet, in all that time, the U.S. stock (market) continued to rally with gusto, totally immune to the swine flu fears.”

So much for information moving the market, they conclude:

“The real story on the U.S. stock market is not written by outside events. It is driven by internal measures of mass social mood, as reflected in Elliott wave patterns unfolding on price charts.”

This is the exact, polar opposite of the school of thinking practiced for decades by an Oklahoma State University agricultural economist who has studied wheat price markets in greater depth than probably any other living person. I interviewed him for a column last week (it won’t be printed until next week) and his view, after incredibly committed observation, is that there’s no way to predict future prices – at all, in any way – and that people shouldn’t even bother trying. To him, information is the one clear, obvious reason for any action in the markets, with information as it is widely disseminated producing an almost arithmetically precise measure of market participants’ rational views about present and future prices. Whatever happened in the stock and commodity markets this week could be completely reduced to a number of factors that moved prices by a certain amount this way and that way as the information spread out and was digested. The market can move too far one way or the other, but it’s always rational, overshooting when it temporarily misjudges new information because that information is only partial.

Typical of this kind of thinking is the idea that if all information was know perfectly, the stock market values and commodity prices would truly reflect the real value of companies and commodities. THere would be no debate. Of course most analysts come somewhere down the middle, generally closer to the latter type of thinking than the former, but almost always leaving some room for sentiment to affect markets in the very short term.

But I’ve gotta say, this week’s continuing stock market rally seems to add a lot of weight to the folks who say sentiment and psychology have a far more profound impact than we ever want to admit. If a suddenly erupting pandemic can’t knock a rally, what can? (Until the sentiment changes . . . )

About the author

Ed White

Ed White

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