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Why are Stocks Rallying? A Look Beneath the Hood

Jul 31, 2012
Chad Karnes, CMT

During earnings season, the focus is on earnings and company guidance. But analyzing more relevant factors provides a much better recipe for stocks that are rising and where they're headed next.

Houdini often used misdirection to help him become one of the most famous magicians in history.  He would focus the audience’s attention elsewhere on an illusion, so they wouldn’t notice what he did to complete his magic trick. 

Today, the media and financial professionals use similar misdirection when trying to explain the stock market’s movements. They focus your attention on earnings and other illusions of today's market when the real driver of price is completely different.

The Illusion

It's earnings season and last week had no shortage of surprises or misdirection.  For example, on Thursday, 7/26, the following S&P 500 (SNP: ^GSPC) companies had negative surprises and guidance at the times given below as reported by Reuters:   

  • 3M (NYSE: MMM)– Missed Revenues at 7:08am CDT on 7/26, but up 1.2% on 7/26 & 7/27
  • Amazon (NasdaqGS: AMZN) – Missed Revenues at 3:08pm CDT on 7/26, but up 7.9% on 7/26 & 7/27
  • International Paper (NYSE: IP) – Missed Revenues at 8:00am CDT on 7/26, but up 2.8% on 7/26 & 7/27
  • Waste Management (NYSE: WM) – Missed Earnings at 6:50am CDT on 7/26, but up 5.7% on 7/26 & 7/27

Although all of these companies missed their numbers, they all have one peculiar thing in common.  Their prices all rose - many drastically.  In fact almost 400 of the 500 S&P 500 companies rose on Thursday (7/26) taking the S&P 500 up 1.6%, even though many of the companies missed their earnings and lowered guidance.    

Per Reuters, “this quarter is the first quarter in three years where earnings are expected to fall year over year”.  So why did prices rise so drastically on Thursday (7/26) and follow through even stronger on Friday (7/27)?  The answer has nothing to do with earnings, buying the negative sentiment, or individual company performance as the media or conventional wisdom would lead us to believe; it is all about the macro-environment, specifically, the Euro, and I will prove it.

The Real Magic Trick

The below chart, provided in the ETF Profit Strategy Newsletter shows the extremely high correlation between the Euro (NYSEArca: FXE) at top and the S&P 500 futures (CME: SPU12.CME) on bottom.  This correlation started at 5am Central Daylight Time (CDT) on 7/26 and continued through 7/27's early afternoon. 

Even more interesting is Thursday’s gains all occurred before any companies even announced their earnings as the chart shows the S&P 500 futures up over 20 points by 7am CDT driven by the extremely large 60 minute move in the Euro that occurred at 6am central on comments out of the ECB.

 

This chart implies that following earnings is a misdirection and trading the earnings certainly wouldn't have made you money.

Factors well out of a company’s control have more impact on share price than company performance or expectations do.  The Euro continued to rise on 7/27 propelling the S&P 500 higher again, making Friday’s earnings another distraction as well. 

A top down, more macro, instead of bottoms up and company specific approach is much more relevant in today’s market environment.  Avoid misdirection by following what really matters.  Along with the Euro, the ETF Profit Strategy Newsletter follows the major macro asset classes and exchange-traded products (ETPs) like the ProShares Ultra Euro (NYSEArca: ULE), the SPDR Gold Shares (NYSEArca: GLD), and the iShares Barclays 20+ Year Treasury Bond (NYSEArca: TLT) to help investors avoid the noise and keep their eye on the real drivers of market prices.

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