Santeri Korpinen, Sifter Fund

Renowned financial author Robert R. Prechter: “Macroeconomic news is useless for predicting the stock market.”

For the first time in quite a while, equity investors had a very good month in July 2022. For example, the S&P 500 went up by 12.7% (EUR), the OMX 25 by 6.7%, and the Sifter Global Fund by 10.6%. Did something happen in the macroeconomic environment in July to drive stock prices higher?

In July, the Fed hiked interest rates aggressively and inflation rose in both Europe and the United States, while China continued to threaten Taiwan and Russia continued its offensive war against Ukraine. At the same time, the Prime Ministers of Italy and the UK resigned and several confidence indices declined.

What should we make of all this?

Is macroeconomic news of any significance to equity investors?

I decided to reach for an 800-page tome on my bookshelf by the name of The Socionomic Theory of Finance, in which the renowned American financial author Robert R. Prechter makes the following claim:

“Macroeconomic news is useless for predicting the stock market.”

Prechter specializes in sociometric economics, which investigates and measures the relationships and effects between people. For his book, Prechter and his team analyzed historical stock prices and macroeconomic events for a period of more than 100 years.

The conclusion drawn by Prechter and his team was that traditional economics does only a passable job of predicting the future.

To be precise, Prechter finds no correlation between macro-level conditions and stock prices.

Traditional thinking in economics and finance relies on the logic of cause and effect: the assumption is that, for example, when the Fed hikes interest rates, stock prices will fall. Prechter’s research refutes that assumption. What about war, acts of terror, presidential elections, and other macro-level events that are considered to be important to investors? No systematic effect in either direction. Isn’t that astonishing?

In his book, Prechter cites dozens of studies and charts that echo the same message.

Stock prices can’t be predicted by changes in the macroeconomic environment.

Prechter’s research gives investors a lot to think about. Many investors constantly try to predict current and future macro situations and make investment decisions based on them.

Hannes Kulvik found two recipes that were acceptable to an engineer

Hannes Kulvik, the founder of the Sifter Fund, reached similar conclusions in his own empirical tests over 30 years ago. Kulvik, an engineer with a Ph.D. in Industrial Economics, was frustrated because there did not seem to be a systematically effective secret recipe for timing the stock markets. After extensive trial and error, he reached the following conclusion:

Buying and selling stocks at the right time is impossible – you ultimately lose more often than you win.

Continuing to look for the secret recipe to investing in the stock markets, Kulvik identified two principles that have been historically effective for over a century: Firstly, instead of trying to read macroeconomic events correctly, you merely need to have the courage to hold shares long enough, even when prices go up or down.

Secondly, you have to make sure that what you own is worth owning.

In other words, you have to avoid lousy companies, companies based on great expectations, and fads. Instead of being lured by bad investments, you need to identify strong and steady performers that grind out growing earnings for their shareholders from one year to the next.

However, a simple buy-and-hold strategy does not work, as changes can happen in companies, and you need to keep a cool head and make adjustments to your portfolio when necessary. To this end, you have to create a systematic process and a model that forces you to make smart moves instead of gambling.

The temptation to deviate from your chosen investment recipe is so big that you have to tattoo your investment strategy on your retinas. It needs to be the guiding light in your eyes and your mind, even in the darkest times of crashing stock markets.

We have also written a quality investing guide called Long-term quality investing. Our guide explains how time and high-quality companies work in an investor’s favor.

The market rises and falls in waves

Let’s get back to Robert Prechter’s book and its key lessons. Is there any rhyme or reason for the movement in stock prices?

As a humanist, Prechter is naturally interested in human behavior. In his book, he presents a model and a theory in which stock prices rise in a series of five waves and fall in a series of three waves.

When the market – i.e. the herd – is in a mood of optimism, the wave goes up even if there is negative news about the macroeconomy.

Many investors have experienced this several times in recent years when it seemed nothing would bring a halt to the rise in stock prices. Equally, when the collective mood of the herd turns negative, even good news will not have a positive impact on stock prices.

Perhaps the most surprising finding in Prechter’s book is that these series of five rising waves and three declining waves repeat very similarly over the decades. In other words, it could be possible to model these waves.

However, the problem once again is timing – how do you determine which wave you are in at any given time?

In our experience, timing the stock market is impossible.

Sifter’s investment strategy is based on the principle that we will perform better by keeping 100% of our assets invested in strong high-quality companies. In the long term, stock prices have ultimately gone up as long as the target companies are good investments that have been carefully analyzed and chosen.

What should we make of the rise in stock prices in July 2022?

Obviously, Prechter’s book does not provide a direct answer to this question. Could it be that the herd mentality has already turned positive toward stocks, in spite of the macro-level data looking terrible? Or was the July rally only a dead cat bounce in a bear market, and the general prevailing sentiment will keep driving prices further down before the mood changes once again? No one can know the answer to this question, so there is no point in guessing.

At Sifter, we will continue to focus on using our systematic process and strategy to identify the world’s highest-quality companies among over 65,000 candidates.

When we identify and invest in strong revenue models backed by competitive advantages, healthy balance sheets, and capable management, we don’t even need to try to make guesses about short-term movements in stock prices.

Interested in long-term quality investing? Download our 20-page guide: Long-term quality investing. Our guide explains how time and high-quality companies work in an investor’s favor.

Santeri Korpinen
CEO, Sifter Capital

Disclaimer. The contents of this page do not constitute investment advice or purchase recommendations for stocks. This page describes our opinions on the companies we have invested in or whose shares we have sold. The past performance of the fund is not a guarantee of future results.
Long-Term Quality Investing - Download the Guide
Long-Term Quality Investing – Download the Guide
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