Stock Move Misunderstanding


Most investors misunderstand when stocks normally rise and fall.

A perfect example of a stock slide misunderstanding appears in the November 1, 2009 article in USA Today’s Money section.

The headlines says: Recent downturn sparks fears of possible market correction.  Drop comes despite good earnings, growth reports”

The point is that we should expect stocks to slide with earnings growth!

The economic cycle has an impact on shares and the cycle reached the stage early this year that we expected shares to rise.

We wrote last February (2009) in Multi Currency Prediction 2009: “we are reaching the phase of the economic cycle when we should be coming out of cash and bonds and into  shares as

* Interest rates are down.

* There is a rush for liquidity.

* Employment is growing.

* Uncertainty is high.

The chart below explains which assets are normally best in various phases of the economic cycle.

multi-currecny-predictions

Equities tend to rise when earnings have fallen or are falling.

Most investors misunderstand the fact that share pries almost always rise at a faster rate than earnings.

This means that shares tend to rise, after a crash even though an economy is faltering.

Once the economy recovers and businesses start to do better,  the big buying is over!  The big investors bought on the bad news (saw good value) and  take profits by selling to small investors who rush in on the good news (as good value falls).

Many statistics suggest that we are entering the period when reducing shares and becoming more liquid makes sense.

Interest rates and inflation are feeling upward pressure.  Bond yields have risen as have P/E ratios and unemployment is looking less severe.

Perhaps that USA Today article should have read: Recent downturn sparks fears of possible market correction.  Drop comes AS EXPECTED along with  good earnings, growth reports”

This is the early stage of the Economic Cycle shift. The same November 1 USA Today Money page also had a headline:  “Economists expect recovery to stick”.

However, this article could be setting small investors up for another panic.

There are still risks of a double dip recession so we should not take anything for granted.  If shares crash again, more buying opportunities will abound.

For now this note just adds a warning of one more downwards dimension in equity markets. This warning goes along with our Triple Crunch Warning of last week made before the Dow crumbled.

Gary

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