When Bad News Is Good News

08/20/2009 9:44 am EST

Focus: MARKETS

Dan Sullivan

Editor, The Chartist

Dan Sullivan, editor of The Chartist, says the market rarely moves the way we expect it to, and investors shouldn’t be too upset about negative economic reports.

As I was driving into work this morning listening to a local radio show, I heard a report that typifies the kind of market action we have had over the past several weeks.

The reporter’s update of current financial news events and summary of what the market was doing went something like this: “This morning’s economic reports continue to show a bleak picture of the economy, with jobless claims up, retail sales dropping, the US consumer remains very weak, and the job situation is dismal.”

After hearing these negative reports, one would expect the market averages to be heavily on the down side. That’s conventional and rational thinking. Lo and behold, the averages were actually up across the board, and when I called the office for an update, our stocks were up 2.5%.

The lesson is that the market often moves against conventional wisdom, and that is why our relative strength strategy is based only on the trend of the market, not the economic news of the day.

Over the past several weeks, many companies have released their quarterly earnings reports, showing profits down 50%-60%. And guess what? The stocks were considerably higher on these reports. Conventional wisdom would say a big drop in profits translates into a big drop in the stock price. Again, the stock market rarely moves with conventional wisdom.

One of the biggest factors driving the markets higher is that alternative investments, particularly money market funds, certificates of deposits (CDs), and US Treasury bills, notes, and bonds, are close to historically low yields. With cash reserves in money market funds estimated to be as much as $3.5 trillion, there is ample money to fuel the market higher.

Not only are US rates at historically low yields; the same situation exists worldwide. It’s incredible to think that $100,000 invested in a money market fund is earning only $250 a year, or approximately $21.00 per month. With the recent statement from the Federal Open Market Committee, it does not sound like the Fed is going to raise rates any time soon.

With most of the market averages [up in double-digit percentages so far this year,] investors are going to be tempted to move a portion of their funds into stocks or stock funds where the potential for a better return exists.

The stock market technically looks in great shape. All of the major averages are above their 50- and 200-day moving average lines. The all-important Advance/Decline Line continued to move sharply higher [as of last week].

Recently the Dow Jones Transportation Average exceeded its January high, confirming the [moves of the] Dow Jones Industrial Average, which had previously bested its January high. According to Dow Theory, this signal indicates a new primary up trend and is a bullish indicator for the stock market.

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