If you really think about it, the stock market closely resembles a living, breathing entity.
It's not a person, I mean, but more like an organism composed of millions and millions of cells. It's each cell that's the person or institution making investment and trading decisions.
While individuals make buy and sell decisions, the pulse of the market and the general movement of the market, one way or another, is more often than not driven by the collective psychology of the organism.
If you understand the collective psychology that's moving the market, you can be exactly where you need to be almost all the time.
When you trade and invest based on the trend, you play stocks from the "long" side (the buy side) when the market's heading solidly, convincingly up.
And you play from the "short" side (short selling or put buying) when the market's trending down.
You'll find it's hard not to make money.
So here's what that giant, moving, thinking thing has on its mind...
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Never Forget: The Trend Is Your Friend
The current state of the market: We've been enjoying an extraordinary - make that historic - bull market since 2009.
In other words, the trend has been solidly up.
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There are lots of reasons you and analysts can come up with as to why the trend has been up. It's a popular media pastime. But it's the broad collective psychology of market participants that reinforces each of the individual metrics that we look at and say, "That's a positive for stocks," that defines the trend.
It's not the other way around. Investors, traders, and analysts don't all look at the same metrics, and even when they do, they don't all interpret them the same way.
But the trend is irrefutable. It's the one metric that matters, always.
The trend only changes when the collective psychology changes. Those changes can be for some short duration, or they can be sea changes that last for years.
Back to the future.
The trend's been up, but the question is (as it always should be) will the trend continue?
To answer that, always ask, in the broadest sense, what's the general psychology about the market?
That's easy to answer...
Here's What I Always Look at to Find the Trend
Forget about daily or weekly market action. That's just the market inhaling and exhaling. It's going to fluctuate, and for the moment, it's down.
Look at graphs of the market over longer timeframes, like quarters and years, and you'll see it's been up.
So, basic psychology is bullish, based on the trend. What's influencing that psychology, making the market go up?
Here's where you look at a handful of metrics:
- The state of the economy, and its prospects going forward.
- The health of corporate earnings.
- The kinds of stocks leading the market - and the investment case for their behavior.
- The performance of the bond market, interest rates, and how the market reacts to their movements.
Really, that's all you need to look at to figure out whether the current trend is intact.
If most of your metrics support the trend, go with it - and keep going with it.
Why the Market Is Bullish on the Economy
When I look at the economy to see if it's growing or slowing, I look at what the GDP numbers are and have been. I also look to see how consumers are faring and what their psychology is.
If consumers are "healthy," that will reflect in the GDP numbers. That's because consumer spending, which, remember, accounts for 2/3 of gross domestic product (GDP) drives production, revenue, and corporate profits. That's what drives stock prices.
GDP's been trending higher. Consumers are in good shape, probably getting into better shape, and they're in a great mood.
But of course, you don't have to take my word for it.
The most recent University of Michigan Consumer Sentiment Index for September came out at 100.8. That's up from 96.2 in August and has been trending up.
The Conference Board's Consumer Confidence Index came in at 138.4 in September, up from 134.7 in August, and has been trending higher too. As a reference, the average CCI from 1952 through the end of 2017 was 83.39.
You can't look at GDP and the economy and not look at unemployment and wages. They've been positive and look like they're going to continue to be positive drivers.
We're hovering just around 4% unemployment and have edged below that low "natural rate." With unemployment low, wages are starting to tick up. More money in consumers' hands is a huge positive.
The economic picture and mindset of consumers is a huge psychological boost for stocks.
There Are No Unicorns Running with the Bulls, Either
To say that corporate earnings have been "trending up" is like calling the Grand Canyon a ditch.
Over the past seven consecutive quarters, corporate earnings growth has averaged 22.2% growth per quarter.
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I've been around a few quarters now, so I'm here to tell you that's better than good - that's staggeringly good.
How good is that? Well, over the previous seven consecutive quarters, earnings growth per quarter averaged -9% per quarter. Strong earnings growth: a huge psychological positive.
The stocks leading the market higher right now are the ones that should be leading the market.
Tech stocks, with millions and in some cases billions of average daily users, members, and subscribers with exponentially growing revenue and net profits are leading the markets higher.
That makes good sense.
There are no hyped-up, unprofitable stocks with fanciful dreams of making money leading the market. There are no groups of sham stocks leading the market.
The psychology is positive because the leadership stocks are all where and what they're supposed to be and are all running on increasing earnings and profits.
This Is the Big Question Facing Us
The bond market... There are some rumblings, but for the most part, it's been doing a whole lot of nothing.
Interest rates are being hiked by the U.S. Federal Reserve - we knew they'd do it, and we know they might do it again - but up until this past Thursday, stocks haven't reacted to this.
Any hiccups in the stock market, especially with the 10-year Treasury yield suddenly spiking, aren't unexpected.
What's important is to see how stocks react to the 10-year getting to 3.25%, a psychologically important level.
As of yesterday, Oct. 8, the 10-year was sitting at 3.23 and creeping north. As you'd expect, stocks were down for the third straight session, but I don't think we'll stay there.
It's OK. Remember, this is the "thing" breathing.
If the stock market sees the 10-year there and, after convulsing, gets back on an upward trend, that's the psychology of the organism telling us it's OK, and that we can interpret higher rates as more a sign of a growing economy - as opposed to some other dislocation somewhere.
When it comes to the Fed, they're not going to risk upending the stock market by raising too fast or too often. So, the psychology should be positive in light of manageable interest rate moves.
So, rates notwithstanding, the stock market is feeling pretty good right now. And if the trend is our friend (and it is), that means we want to be long.
If any of our at-a-glance metrics change - should the economy slow, for instance, or should we be unable to make sense of the stocks leading the market - then we want to watch for the beast to start heading the other way.
Now that you know what to watch, you'll know it when it happens. And I'll be in touch with some of my favorite short-side moneymakers.
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About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.
Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.
Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.