Sentiment Speaks: Why Would The Market Rally After The CPI Report?

(This article was first published Oct 16 on Seeking Alpha.)

This past week did not go exactly as most expected... did it?

On October 11, just two days before the CPI number was announced, Bloomberg ran an article entitled, “JPMorgan Says Too-Hot CPI Would Put Stocks at Risk of 5% Tumble.” And, they were not the only one.

Then, on Thursday morning, the CPI report outlined that inflation was hotter than expectations. And, while the market did drop pre-market, the day ended quite differently. In fact, by the time we closed, the market rallied almost 6% off the lows, and ended up green by over 2.6%.

And, boy, did it leave people scratching their heads. I saw quite a few comments on Seeking Alpha which mirror this sentiment:

“Am I the only one wondering what the heck is going on with this market? I feel like it makes no sense anymore.. Today made NO sense.”

In fact, in a Barron’s article later that day, the author outlined the common feeling in the market that day:

“It was a massive rally, and one that came out of nowhere. And it’s left market observers like yours truly wondering what the heck just happened. There wasn’t any new data, no headline-making speeches, no event that occurred just after the open to spur such a move. It literally came out of nowhere—and left us grasping for possible reasons. “Today’s market reversal was a head-scratcher,” writes Oanda’s Edward Moya. And he’s not wrong.”

Within my update on Wednesday evening to the members of ElliottWaveTrader, I outlined my views regarding how we do not always need a market catalyst to start the rally I was expecting to begin in the near term. In fact, I again highlighted some of the points which supported my view that a positive market catalyst is not needed in order for the market to bottom and begin the large rally I was expecting:

I want to remind everyone of something that Alan Greenspan said 20+ years ago:

“It's only when the markets are perceived to have exhausted themselves on the downside that they turn. . . ”

Now, sometimes, we can see a catalyst which triggers the move in the opposite direction. Yet, it is not really needed, as many market studies have shown that many large moves do not even see a catalyst.

In a 1988 study conducted by Cutler, Poterba, and Summers entitled “What Moves Stock Prices,” they reviewed stock market price action after major economic or other type of news (including major political events) in order to develop a model through which one would be able to predict market moves RETROSPECTIVELY. Yes, you heard me right. They were not even at the stage yet of developing a prospective prediction model.

However, the study concluded that “[m]acroeconomic news . . . explains only about one fifth of the movements in stock market prices.” In fact, they even noted that “many of the largest market movements in recent years have occurred on days when there were no major news events.” They also concluded that “[t]here is surprisingly small effect [from] big news [of] political developments . . . and international events.” They also suggest that:

“The relatively small market responses to such news, along with evidence that large market moves often occur on days without any identifiable major news releases casts doubt on the view that stock price movements are fully explicable by news. . . “

In August 1998, the Atlanta Journal-Constitution published an article by Tom Walker, who conducted his own study of 42 years’ worth of “surprise” news events and the stock market’s corresponding reactions. His conclusion, which will be surprising to most, was that it was exceptionally difficult to identify a connection between market trading and dramatic surprise news. Based upon Walker's study and conclusions, even if you had the news beforehand, you would still not be able to determine the direction of the market only based upon such news.

In 2008, another study was conducted, in which they reviewed more than 90,000 news items relevant to hundreds of stocks over a two-year period. They concluded that large movements in the stocks were NOT linked to any news items:

“Most such jumps weren’t directly associated with any news at all, and most news items didn’t cause any jumps.”

I then concluded my update with the following:

“Thus far, the market has made several attempts at hitting the blue box support region on the 60-minute SPX chart. And, each time, divergences continue to grow. And, if you look at the 5-minute SPX chart, there is still opportunity to actually strike that support below as long as we remain below the smaller degree resistance noted. . . But, I think we will likely be much higher than where we stand today as we look out towards the end of October, or even into early November, depending on how long it takes the market to bottom out, and how fast the rally I expect takes hold.”

And, not only did we not get a bullish catalyst to begin the rally we saw on Thursday, but we got a bearish catalyst in the CPI report. Yet the market moved in the exact opposite manner everyone expected due to the hotter than expected inflation report.

In fact, before the market opened on Thursday morning, and as it was hovering near the recent lows, I sent out an alert to our members at 8:56AM, noting my expectations for a bottom being struck and noting that “[t]his should now be the selling climax that completes the downside structure.” The market bottomed within half hour of my alert.

Now, please take note that my views were not based upon economics, upon news, or upon anything other than mathematics. In fact, the market shocked those outside my service with this turnaround, as outlined by the Barron’s article cited above. But, our members were quite prepared for a potential rally to begin:

“...today was like EW proof on steroids. Had an up 8% portfolio run - including selling shorts at the bottom and immediately loading up on the turn. Without this service I would never have been poised to jump that quick. The confidence of recent updates was pretty overwhelming.”

“Just want to say that was an amazing call this morning.. I have been a member for about 8 months. Definitely an elliot wave neophyte, but lots of trading experience. just amazed. i be 62, old dawg. great, great service.”

Yet, I am quite confident that most of you reading this article will simply dismiss what occurred on Thursday, put your blinders back on, and move on to the next economic report or piece of news to determine the next market directional move.

So, I want to take this moment to again cite something from Bob Prechter’s seminal book The Socionomic Theory of Finance (which I strongly urge every single investor who wants to really understand the market, and days like Thursday, to read):

“Observers’ job, as they see it, is simply to identify which external events caused whatever price changes occur. When news seems to coincide sensibly with market movement, they presume a causal relationship. When news doesn’t fit, they attempt to devise a cause-and-effect structure to make it fit. When they cannot even devise a plausible way to twist the news into justifying market action, they chalk up the market moves to “psychology,” which means that, despite a plethora of news and numerous inventive ways to interpret it, their imaginations aren’t prodigious enough to concoct a credible causal story.

Most of the time it is easy for observers to believe in news causality. Financial markets fluctuate constantly, and news comes out constantly, and sometimes the two elements coincide well enough to reinforce commentators’ mental bias towards mechanical cause and effect. When news and the market fail to coincide, they shrug and disregard the inconsistency. Those operating under the mechanics paradigm in finance never seem to see or care that these glaring anomalies exist.”

And, to just add a few more points for those that are still unconvinced, these are what some of my members have noted about their real-world experience:

“I worked as a trader in EF HUTTON's Government Bond Dept. in years encompassing the last great inflation. We sometimes got 'privileged' information. [Usually through past Federal Reserve staff that decided to 'go work for the street'.] I can attest that that having such information beforehand, and positioning with it was just at least as often a disaster as a boon. You MUST learn to ignore it. . . AVI is 100% right IMHO.”

Many people continue to argue with me that something has to change sentiment, like a news event or some economic news, for the market to change direction as it did on Thursday. Yet, I continually answer them that it is simply a reaction in the human biological condition. Once sentiment reaches an extreme in one direction, there is only one way left for it to go. And, that is how we get sentiment changes. We saw this quite obviously on Thursday. There was no reason for it to change from an exogenous perspective. Yet, it did change. And, if this does not make you reconsider your prior perspective of exogenous causation, then I am not sure what will.

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