The Bad News is Out There

 
When a market commentator or stock analyst starts saying, “Well, the bad news is out there,” chances are that they’re talking about a country or a stock that’s been having a bad time of it.

This old market axiom is usually invoked as a way to calm investors down about the possible continuing dire effects of bad news on the market. Investors see, for instance, that a negative piece of economic news has caused a dip in Chinese stocks, and they get a picture in their heads of a Chinese stock being brought down like a rodeo cowboy dogging a steer.

Fortunately, the market is actually a very efficient discounter of information. Any piece of bad news is like a bit of data entered into an enormous computer; it gets chewed up and added to all the other data and registered in the program’s output almost immediately.

Even big events like a Fed rate hike or a new estimate of China’s GDP growth can be digested by the market in a few hours.

So when a piece of bad news hits the ticker, investing pros know that today’s reaction will be history by tomorrow’s open.

The PowerShares Golden Dragon Halter USX China ETF (PGJ) took a major hit from December 24, when it reached an intraday high at 33.8, to January 20, when it dipped intraday to 27.5. The Golden Dragon threw some high-volume down days during that run, especially January 4 and 7, leading to a nearly 19% haircut, which is a significant correction.

But the other side of that coin is that PGJ has now closed between 28 and 30 for the past 13 trading sessions, with volume on the calm side. That looks like the kind of range-bound sideways trading that might be the start of a new base.

The contention here isn’t that Chinese ADRs on U.S. exchanges have put in a bottom. That will take a much longer time to develop, and will only be obvious in retrospect.

The point is that even with all the bad news raining down about the Chinese economy and the Chinese government’s apparent inability to rev things up, investors are holding pretty steady on their China bets. They have turned the cranks on their discounting machines and decided that they will leave their positions about where they are. At least until any unexpected bad news hits their computer screens.

Markets bottom when the last discouraged investors finally sell their positions and head for their local tavern to complain about their bad luck and the unfairness of the stock market. That’s the moment of maximum despair, and you can’t have a market bottom without that kind of pain.

Pain levels are pretty elevated right now, with more than 80% of all stocks on the New York Stock Exchange and the Nasdaq sitting under their 200-day moving averages. That’s a pretty extreme reading, and it’s matched by decade-long lows in investor sentiment.

We will continue to hold off on new investments and will keep our holdings on short leashes. That’s the only real protection we have against a bearish market.

But we also know that markets must receive a continuing diet of new bad news in order to stay in a correction mode, and the dire reports on the Chinese economy are getting a little stale. We’ll see what happens.


This is an excerpt from Cabot Emerging Markets Investor, which seeks to capitalize on the enormous potential in emerging market countries. Chief Analyst Paul Goodwin has been a researcher and writer for over 30 years and a member of the Cabot investment team since 2005.

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