The following series is excerpted from two classic issues of Robert Prechter’s Elliott Wave Theorist. Although originally published in 2004, the valuable series has been re-released in the Independent Investor eBook, along with over 100 pages of other reports that challenge conventional economic thinking.
Here is Part IV of the series. Click these links to read Part I, Part II, and Part III. Or you can download your free copy of the Independent Investor eBook here.
Another Example of Rationalization, Ripped from the Headlines Almost every day brings another example of rationalization in defense of the idea that news moves markets. The stock market rallied for half an hour on the morning of April 20, peaked at 10:00 a.m., and sold off for the rest of the day. Almost every newspaper and wire service claims that the market sold off because “Greenspan told Congress that the nation’s banking system is well prepared to deal with rising rates, which the market interpreted as a new signal the Fed will tighten its policy sooner rather than later.”3 Is this explanation plausible?
Point #1: Greenspan began speaking around 2:30, but the market had already peaked at 10:00.
Point #2: Greenspan said something favorable about the banking system, not unfavorable about rates. A caption in The Wall Street Journal reads, “Greenspan smiles, markets don’t.”4 The real story here is that the market went down despite his upbeat comments, not because of them.
Point #3: Greenspan’s speech was not the only news available. Most of the other news that day was good as well. As the AP reported, profits of corporations were good and “most economists don’t expect the Fed to raise rates at its next meeting.” So if news were causal, then on balance the market should have risen.
Point #4: The Fed’s interest rate changes lag the market’s interest rate changes. Interest rates had moved higher for months. Even if Greenspan had stated (which he didn’t) that the Fed would raise its Federal Funds rate immediately, it would have been no surprise.
Point #5: Greenspan said nothing that people didn’t already know, so while the fact of the speech was news, there was no news in the content of the speech.
Point #6: The simultaneously reported fact that “most economists don’t expect the Fed to raise rates at its next meeting” contradicts the argument for why investors sold stocks. If economists don’t believe it, why should we think that anyone else does?
Point #7: Greenspan did not say that rates would go up.
Point #8: We have no data on the history of stock market movement following mere hints of a possible rates rise, which means no data on which commentators could justifiably base an explanation of the market’s apparent reaction to such a hint, if in fact there was one.
Point #9: There is no evidence that a rise in interest rates makes the stock market go down. In 1992, the Federal Funds rate was 3 percent. In December 1999, it was 5.5 percent. The Dow didn’t go down during that time; it tripled. Rates also rose from the late 1940s to the late 1960s, during almost all of which time there was a huge bull market. Ned Davis Research has done the research and found that in the 22 instances of a single rate hike since 1917, “the Dow was always higher…whether three months, six months, one year or two years later.”5 In other words, if interest rates truly cause market movements, then a rate rise would be bullish. According to Davis, it takes a series of four to six rate increases to hurt the market, and that’s if you allow the supposed negative causality to appear up to twelve months later! So even accepting the bogus claim of causality would mean that investors would have had to read into Greenspan’s optimistic comment on the banking system a whole series of four to six rate rises, after which maybe the market would go down within a year after the final one! (The truth is that rising central-bank rates are usually a function of a strong economy, so many rate increases in a row simply mean that an economic expansion is aging, from which point a contraction eventually emerges naturally. Interest rates, like all other financial prices, are determined by the same society that determines stock prices. It’s all part of the flux within the same system. Changes in interest rates are not an external cause of stock price movements, just as stock price movements are not an external cause of changes in interest rates.)
So why did so many people conclude that Greenspan’s speech made the market go down? They didn’t conclude it from any applicable data; they just made it up. The range of errors required for people to concoct such “analysis” is immense, from an inapplicable chronology to contradictory facts to an utter lack of confirming data to a false underlying theory. Yet it happened; in fact, it happens every day.
Quiz: What does this sentence from the AP article mean? “Worries that interest rates will rise sooner rather than later have distracted investors from profit reports this earnings season.” Answer: It simply means, “The market went down today.” There is no other meaning in all those words.
