Monday, July 27, 2009

Weekly Stock Pick

Buy Sell Hold
Earnings: Is That REALLY What's Driving The Market Higher?

By Bob Prechter Elliottwave

It's the season for corporations to report their earnings, and everywhere you turn, analysts talk about the influence of earnings the broad stock market:

Street Gains On JPMorgan Earnings, Economy (Forbes)

Wall St slips as earnings spur caution (Reuters)

Stocks Show Little Reaction to Latest Earnings (The New York Times)

With so much emphasis on earnings, what you're about to read next 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. Bob Prechter, EWI's founder and CEO, presented some of it in his 1999 Wave Principle of Human Social Behavior (excerpt):

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.

S&P500 Earnings Chart
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 a downturn in stock prices. This was certainly true in 2000, as the chart above 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.

"Simple logic based on external causes does not work in predicting financial markets," Bob Prechter explained in his June 2009 Elliott Wave Theorist. Try putting social mood first -- our publications can help you do that right now, risk-free. Click here for a free trial to find out for yourself.

My Stock Pick This Week

Is a short-sell on a big Cable TV company that the market loves to death right now. See my sell-short plan below. I base my buy and sell decisions based on psychology and sentiment mostly. Charts tell the current story on the fear and greed question, what I also call “the illusion of value game”. Successfully profiting long term from investing or trading in the markets is about when you’re wrong, you’re wrong small, and when you’re right, you’re right big. Reward versus risk. The pros know and use this, amateurs, don’t. The same applies to all of life in my opinion.

Yes I do look at fundamentals in my analysis, but as history has proven time and time again, sometimes stock prices fit into the fundamentals, and sometimes not. This is hardly a low-risk high-reward strategy to invest and trade the markets.

There’s a saying that an “economist is a trader in hindsight”. Meaning an economist tries to make sense out of what might happen in the future or has already happened in the market, and if he happens to be wrong, no worries, he’s doesn’t have any money on the line to lose over his wrong analysis. Amateurs and pros alike can be can wrong. The difference between the amateurs and the pros is that the pros have a plan to keep their losses small, and the amateurs don’t.

A successful trader who puts real money on the line, looks at the market to find low-risk high-reward chart price setups that can possibly provide 3:1 plus rewards and if wrong a small loss. Long term this is a strategy for long term success in investing and trading the markets.

Another saying, “Amateurs want to be right. Professionals want to make money”. Meaning that Amateurs go into the market without a real plan of first knowing at what price to enter a position and at what price to exit the position with profit or small loss, and for the human nature sake of wanting to be right, ride out painful losses until they are too much to bear, and take a big loss or get wiped out. Professionals have a system, which tells them at what price to enter long or short, a stop-loss price if the trade does not go their way, and take profit price targets to exit their positions with a profit. Professionals do not enter investments or trades without knowing this vital information first.

As an investor or trader, the real questions to be finding out which may be very hard to know exactly by the average investor trader, is who’s already got a position, how big their position is, is it short or long or both, at what price will they be exiting that position, and the same for any new position being considered. The insiders, big market players, NASDAQ market makers, specialists on the NYSE floor have this information, but the average retail investor trader does not so easily. The odds are in the pros favor.

Listening to the spin of news, fundamental reports, analyst’s recommendations, etc is a high-risk low-reward way to invest trade the markets. The funny thing about money, and a lot of it, people will say and do things they normally wouldn’t say or do.

So what’s the solution to this situation? Have and stick to a system of investing trading the markets that provide low-risk high-reward returns. Knowing at what price you will enter at, and what price you will exit at with a projected 3:1 plus ratio profit or loss. Also very important for those leveraging on margin is not to over leverage your positions and investing trading account. Below is a typical low-risk high-reward trade setup. Follow a system like this, and you’ll win some lose some, and in the long term, you’ll win at the investing trading illusion of value game. The fact is no one really knows what drives stock prices. I would suggest its fear greed and the collective social mood of the times. The pro traders are excellent reads on attaining higher than average returns in the markets. Knowledge > Goals > Plan > Action > Success

Sell-Short Shaw Communications Ticker SJR

Sell Entry: 17.52 to 17.19

Stop-Loss: 17.86

Take Profit Areas: 16.86 to 16.20, 13.44 to 12.89, 12.34 to 11.84

Shaw Communications Company Profile

Shaw Communications, Inc., a diversified communications company, provides broadband cable television services, Internet, digital phone, telecommunications services, Direct-to-home (DTH) satellite services, and satellite distribution services primarily in Canada and the United States. The company’s cable television services include cable and extended tiers, digital cable, pay television and pay-per-view, video-on-demand, bundling of services, and new video services. It also provides high speed Internet access services to residential and business subscribers. The company’s digital phone services include local residential line and long distance calling, as well as calling features, including voicemail, call display, call forwarding, three-way calling, call return, and call waiting. In addition, it operates a fiber network that serves as a platform for voice services, IP-based services, business-to-business services, and video. Further, the company distributes digital video and audio programming services through DTH satellite to residences and businesses; uplinks and redistributes television and radio signals through satellite to cable operators and other distributors, and related network services; and provides satellite tracking and messaging services to the trucking industry, as well as integrates and manages satellite data networks with land-based telecommunications. Additionally, it owns and leases, directly and indirectly, satellite transponders that receive and amplify digital signals and transmit them to receiving dishes located within the footprint covered by the satellite. As of August 31, 2008, the company had 906,320 digital cable customers, and 611,931 digital phone lines; and 892,528 DTH subscribers. Shaw Communications, Inc., formerly known as Capital Cable Television Co., Ltd., was founded in 1966 and is headquartered in Calgary, Canada.

Click here to review and trial the Trading Software we used in determining our short position on SJR.

Click the Shaw Communications Stock Chart for a larger view.

Shaw Communications Stock Chart