Response to reader question regarding correlation of outside events to market moves.

Reader "L" wrote,"You have been saying for some time that we should expect a significant correction in the markets, Dow, S&P... and at the same time a rise in rates. What bothers me is that historically rates and stocks move together, at least on daily time scales, no so true over decades, why would it be different this time?".

This is an important question which I have addressed indirectly many times in this blog based on the teachings of Bob Prechter and socionomics.  I'm not just parroting what he is saying blindly.  I have questioned his logic over and over again in real life and I believe that he is essentially correct even though I don't really like how he explains it.  While his explanations in debunking what he calls the exogenous effect theory are correct and based on data (Prechter is above all a statistician and a historian) he then just says "and so forget about those things, use EW instead".

This is a particularly unappealing approach to teaching because it leaves an unfilled hole in our brain, one that screams to be filled with some kind of answer, some kind of logic.

So first, I will present Prechter's views and then I will add my own opinion to try to fill the resulting gaps.  Interestingly, Prechter just did a video on the subject for the State of the Global Markets 2015 Online Conference but it was a limited time resource for subscribers only.  In it Prechter used historical data to completely debunk many common correlations between stock market moves and exogenous events like:

• interest rate moves
• inflation/disinflation
• terrorism
• etc.

I cannot explain this to people in words because people have already been conditioned, brain washed, indoctrinated, what ever you want to call it into a certain belief system that the herd has endorsed as its own.  A careful study of the human herd will show over and over again that the herd often believes things that are not true despite all the evidence in the world against it.  This is why declaring that the Earth is round instead of flat, that Earth revolves around the sun and not the other way around were prisonable events in their time.  The herd had its mind made up and would not be confused with the facts.  Again, why do you think we got liars and con men like Clinton, Bush and Obama instead of visionary smart guys like Ross Perot and Ron Paul?  Same reason.

The only way to really explain things to those who can hear (as in "are open minded enough to let logic and data override their herding instincts", which is a very small percentage of the population, sadly), is with data.  Prechter's recent vid was loaded with charts and data showing how there is no reliable relationship between exogenous events and market moves.

I have a slightly different take.  There is a reliable relationship but you have to be omniscient like God in order to perceive it.

We have all heard about rogue waves in the ocean.  There are usually a small number of them rolling around out there at any time.  They occur even if there is no Earthquake, underwater landslide, volcano eruption or asteroid splash to account for them.  They occur due to the randomness of waves and how waves add and subtract from each other in a completely mathematical way but in a way that is so complex that we are not smart or observant enough to have any chance of predicting them.  In other words, it would take someone with Godlike powers of not only observation (omniscience) but also of processing capability (omnipotence) in order to do this and humans do not meet these requirements.

In fact exogenous events DO account for rogue waves but there are so many of them interacting in so many ways and to so many degrees per way that it is a fool's errand to try to predict them and I think that the markets work in the same way.  This is a more detailed way of explaining the so called butterfly effect which of course itself is just a partial explanation since it makes it sound like the butterfly wings cause weather events in and of themselves when the reality is that they can combine just right with other things to form the behavior.  In other words, they are a catalyst, and perhaps one of many, not root cause in and of itself.  To say that interest rates do not effect stocks at all makes no sense. 

The problem is, however, saying how and to what degree it will effect them and this is where THE DATA shows that the correlation is so unrepeatable that it essentially appears to be random to our unGodlike sensory input and processing power.  Again, the data is truth despite the "world is flat" herd beliefs that herd members are so sure they "know" about.  If honesty is taken into account, they never did any real research of their own, they don't know anything about it at all and they simply repeated the current herd think as if it were fact.  Hearsay is a basic element of herding. We all do this, it is part of our built in wiring and even those who are aware of it must fight it every day in order to see clearly.  It is that ingrained into us.  It is in our DNA.

Take today's Fed announcement as an example.  Despite L's comment that "historically rates and stocks move together, at least on daily time scales" (which is already busted based on stocks up since 2009 while interest rates have been, on average, falling with no daily correlation that I have ever been able to discern),  the markets have in general been loving all of the low interest rates.  The traders loaded up on cheap margin sending stocks to ridiculous highs.  Now Yellen says today "no change" and the markets sold off.  Note, markets did not move all that far today; the real underlying sentiment was felt by UVXY which closed up 18%!   Why did this happen?  I thought low rates were good for the markets?  The interest rates went down even more today!  Also, low interest rates are supposed to mean more money printing yet the miners pulled back hard as well.  Correlation is bust.

The key here is to avoid the word "believe".  When you say believe in conjunction with trading you are saying "gut feeling".  If on the other hand you say "the data shows" and then provide said data then you are no longer in the land of beliefs (or make believe) but rather rooted to facts.  Facts are the anchor that holds you fast while the tide would like to wash you out to sea.  I'm sorry I cannot share the recent EWI vid because it had so many good historical charts and so much good data but here is a shorter vid that only very quickly touches on the subject with one quick chart flashed on the screen for a very short period of time.  You might be able to find more if you look.

As for my view that rising rates will fuel the crash THIS TIME, I base this BELIEF completely on the fact that margin debt is at an all time high THIS TIME.  When rates are low, the service on margin debt is possible.  More debt enables more profits.  And so that is what happens.  More profits means more reinvestment and the cycle is self reinforcing.  While stocks can begin down before the interest rates begin to rise (thus proving that the direct cause-effect is not there), once stocks are headed down a rise in interest rates is LIKELY to accelerate the sell off to the downside IMVHO simply because margin debt service goes up with interest rates.

Having said that, these are just beliefs and I don't do any real market timing using them. There could be some other incoming wave that I am not smart enough to see.  Some wave whose net interaction is to keep interest rates low while the market sells off.  The main reason I see rates going up is its current wave count for interest rates.  The main reason I see the broader markets ready to sell off is wave count for stocks.  The interaction between the two is not reliably knowable according to the data presented by Prechter.

So the bottom line is that the only evaluation that we humans have any chance of success with is to look at the individual waves associated with the asset we are looking at and not spend too much effort trying to make relationships between waves.  Like fundamentals, the wave interactions are, at the end of the day, unknown and unknowable by mortal man.