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The Stock Market is Waiting for More Bad News to Rise Further

No, it’s not a typo: the stock market is waiting for more bad news to rise further because all the possible good news is already discounted. Only through bad news the market can short squeeze its way to new highs. We saw that already with Ebola, Ukraine and Middle East fighting. Bad news is good news for this market.

The latest V-bottom equated to a more than 12% rise from its lowest low in 19 days and a gain of 9.6% on a closing basis in SPY.  These are not numbers you see every year. The last time this kind of performance was observed was near the end of the 2011 correction (see relevant post here).

SPY_20141111

The mechanics of the stock market V-bottoms are in principle simple and there is not any conspiracy to drive prices up but this only happens due to the fact that bulls often have higher purchasing power than bears. When there is bad news, bulls stay on the sidelines but bears jump in hoping that the time has come for their vindication. As the market drops due to shorting and absence of buyers, passive index funds accumulate cash that they must put to work to make their commissions. At some point these funds move in massively and buy stocks ignoring any bad news because for them the market is invincible (Do not blame Bayes for that.) Then, bears are squeezed out and the market rallies to new highs in the process.

This will continue, i.e. bad news will mean good news for the market, as long as retail investors continue to send money to fund managers to buy stocks indiscriminately, without paying any attention to fundamentals. Note that this can go on for many years but it is a game that has a sad expiration date. It is like those early video game machines that worked with coins and when the time was up the screen went off regardless of whether the player was winning or not. During this time active investing underperforms passive index tracking and the huge industry of buy and hope makes sure this fact makes the headlines almost every other day but at some point the clients of competent financial advisers will have the last word when the passive index funds will face a drawdown similar to those after the last two market tops.

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Disclosure: no relevant positions.
Charting program: Amibroker
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