The Holy Message of the Markets

Gunning Ju  |

Image via Fabricio Cardenas/Wikimedia

The markets melted up after French pro-Euro candidate Emmanuel Macron and anti-Euro nationalist Marine Le Pen advanced to run-off for president of France on May 7, anticipating the results before the round one election on April 23, with French and German stock indexes each reluctantly slipping about 3%, and supporting at 50-day moving average line. How is it possible? Or what else did the markets expect?

Many pundits think the market rally after the round one election may signify that Pro-Euro Centrist Mr. Macron will defeat anti-immigration far right leader Ms. Len Pen. According to media polls, Mr. Macron has 60% of chance to win versus Ms. Len Pen, who has a 40% in odds, in the second round this Sunday.

However, this opinion is too optimistic. As a matter of truth, among eleven candidates in the first round, if other anti-Euro leaders’ voters switch to Ms. Le Pen, then she will possibly receive approximately 48% of votes, marginally less than 52% votes obtained by Mr. Macron with all other Pro-Euro leaders’ votes. This could be a close call. Like the November U.S. election, a close call could swing to a totally different result, even then the markets got it wrong. So what’s wrong with the market discounting mechanism? Let’s first recount a historical myriad episode.

At about 11:39 AM on January 28, 1986, the space shuttle Challenger exploded ten miles in the sky one minute 14 seconds after it blasted off from its launch pad. Within minutes, investors began selling four major defense shares: Rockwell International, Lockheed, Martin Marietta, and Morton Thiokol. Morton Thiokol’s shares dropped 12%, hardest hit among the four stocks. This implied that the stock market had almost immediately sorted out Morton Thiokol as the primary target of disaster. Later research showed no insider selling or any other information that can explain how investors picked Thiokol. How did the market get it right?

As James Surowiecki wrote in his intriguing book — The Wisdom of Crowds, the stock market was smart that day when it satisfied the four conditions that characterized wise crowds: diversity of opinion, independence, decentralization, and aggregation. The judgement based on those four conditions is likely to be accurate…And with decision making, it’s often excellent.

One possible explanation could be: thousands of informed or uninformed investors around the world bid down the defense stock prices, with some overreacting, while others underreacting; Overreaction counterbalanced underreaction, thus achieving an agreement between buyers and sellers and discovering the right target. This is a holy market mechanism for aggregating the collective wisdom of investors.

In contrast to most polls that showed non-Brexit last year, the London Financial Times Index started dropping and predicted Brexit well before June 23 Brexit referendum. But the market did foretell the winner of U.S. popular vote last November while wrong about the electoral college vote. This may result from a flawed electoral college system that disrupted the independence of investors’ judgement through winners taking all votes in a state.

The French election method is different from the U.S. electoral system without distorting voters’ independence.

The developed markets appear to prophesize the right result on May 7’s French election, whereas both Mr. Macron and Ms. Le Pen have virtually equal chance to prevail. Maybe markets anticipate that France will not exit the EU at all, even if Ms. Le Pen does triumph. Or if France does elect out of the EU, the new chapter of Eurozone will not be as gloomy as most people perceive. Either case could be fine for the markets. Or less likely, opposite situationS will happen dependent on what the markets telegraph us this week.

The markets rose powerfully last week as more positive catalysts followed the upswing. If Mr. Trump’s tax cut plan can pass Congress, that will increase S&P 500 earnings by at least 10% in 2018, if other things being equal. And we could see DJIA 22000 and S&P500 2500 this year.

The four stocks I mentioned on February 1 for Trump 100 day play are worthy commenting again here.

  • TAL Education (TAL) hit target $120 on April 27, up more than 50% so far and piecing from upper channel line, a possible sell signal.
  • Western Digital (WDC) last Thursday reported 97% earnings growth with revenue up by 64% first quarter. So you can hold it longer, looking for $120 target.
  • Alibaba (BABA) slowly climbed and can move higher, and investors could sit tight.
  • Mercury System (MRCY) also released upbeat earnings reports last week. However, the stock prices fell below 10 week line and are forming a base, so sell shares first and wait for better entry points when its price backs up to 10 week line again.
  • Total System Services Inc. (TSS), a payment service provider in Columbus, Georgia, delivered a solid earnings report recently. Its stock price broke out from 16-month’s consolidation, and you could buy weakness.

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This is just a personal opinion, and personal opinion is often wrong. Currently, the author has no position on any of the above mentioned stocks, and may or may not build any position on any stocks above in the future.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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