Is That REALLY What’s Driving The DJIA Higher?

By Vadim Pokhlebkin

It’s corporate earnings season again, and everywhere you turn, analysts talk about the influence of earnings on the broad stock market:

• US Stocks Surge On Data, 3Q Earnings From JPMorgan, Intel (Wall Street Journal)
• Stocks Open Down on J&J Earnings (Washington Post)
• European Stocks Surge; US Earnings Lift Mood (Wall Street Journal)

With so much emphasis on earnings, this may come as a shock: The idea of earnings driving the broad stock market is a myth.

When making a statement like that, you’d better have proof. Robert Prechter, EWI’s founder and CEO, presented some of it in his 1999 Wave Principle of Human Social Behavior (excerpt; italics added):

Are stocks driven by corporate earnings? In June 1991, The Wall Street Journal reported on a study by Goldman Sachs’s Barrie Wigmore, who found that “only 35% of stock price growth [in the 1980s] can be attributed to earnings and interest rates.” Wigmore concludes that all the rest is due simply to changing social attitudes toward holding stocks. Says the Journal, “[This] may have just blown a hole through this most cherished of Wall Street convictions.”

What about simply the trend of earnings vs. the stock market? Well, since 1932, corporate profits have been down in 19 years. The Dow rose in 14 of those years. In 1973-74, the Dow fell 46% while earnings rose 47%. 12-month earnings peaked at the bear market low. Earnings do not drive stocks.

And in 2004, EWI’s monthly Elliott Wave Financial Forecast added this chart and comment:

Earnings don’t drive stock prices. We’ve said it a thousand times and showed the history that proves the point time and again. But that’s not to say earnings don’t matter. When earnings give investors a rising sense of confidence, they can be a powerful backdrop for adownturn in stock prices. This was certainly true in 2000, as the chart shows. Peak earnings coincided with the stock market’s all-time high and stayed strong right through the third quarter before finally succumbing to the bear market in stock prices. Investors who bought stocks based on strong earnings (and the trend of higher earnings) got killed.

So if earnings don’t drive the stock market’s broad trend, what does? The Elliott Wave Principle says that what shapes stock market trends is how investors collectively feel about the future. Investors’ mood — or social mood — changes before “the fundamentals” reflect that change, which is why trying to predict the markets by following the earnings reports and other “fundamentals” will often leave you puzzled. The chart above makes that clear.

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Death of the Dollar, Again

By Nico Isaac

If you want the latest news on the U.S. Dollar Index, try a search under its new ticker symbol, RIP. — as in, “rest in peace.” Let the record show: In the early morning hours of Tuesday, October 6, the mainstream financial community officially declared “The Demise of the Dollar” (The Independent).
The “coroner’s report” cites these details as the causes of death:

• An alleged (and later denied) secret meeting among leaders of certain Arab States, China, Russia, and France which aimed for the immediate discontinuation of oil trading in U.S. dollars.
• And, an open statement from one senior United Nations official that proposed the dollar be replaced as the world’s reserve currency.

In the words of a recent Washington Post story: “The growing international chorus wants the dollar replaced… a move that would end the greenback’s six-decades of global dominance.”

And with that, the line between negative sentiment — AND — “EXTREME” negative sentiment was crossed. It occurs when the beliefs about a market lean so far over in one direction, that the boat investors are sitting in is about to tip over… Just like the last time.

Case in point: Spring 2008. The U.S. dollar stood at an all-time record low against the euro after plunging more than 40% in value. And, according to the usual experts, the greenback was “dead”-set to meet its maker. On this, these news items from early 2008 say plenty:

• “The dollar is a terribly flawed currency and its days are numbered.” (Wall Street Journal quote)
• “It’s basically the end of a 60-year period of continuing credit expansion based on the dollar as the world’s reserve currency.” (George Soros at the World Economic Forum)
• “Greenback is losing Global Appeal… the ‘Almighty’ Dollar is Gone.” (Associated Press)

YET — from its March 2008 bottom, the U.S. dollar came back to life with a vengeance, soaring in a one-year long winning streak to multi-year highs. In the most current Elliott Wave Theorist (published September 15, 2009), Bob Prechter presents the following close-up of the Dollar Index since that trend-turning bottom. (some Elliott wave labels have been removed for this publication)

At a measly 6% bulls, the bearish dollar boat tipped over. The situation today is even more remarkable: The percentage of bulls is lower, at 3-4%, while the dollar’s value is higher than the March 2008 level.

It’s crucial to understand that markets don’t necessarily respond to sentiment extremes immediately. But, such extremes do indicate exhaustion of the trend — which is usually the opposite of what the mainstream expects.

For more information, download Robert Prechter’s free Independent Investor eBook. The 75-page resource teaches investors to think independently by challenging conventional financial market assumptions.