In theory, the stock market is supposed to be a discounting mechanism. It is supposed to determine the value of news -- like a deal on China trade -- and price its value into the market. The textbooks tell us that price is determined by the efficient discounting of future events.
If you embrace that theory, then well-anticipated events, such as President Trump's announcement that there is significant progress on China trade and that March 1 tariffs are being delayed, should have minimal impact on the market. This news has been anticipated for weeks and the market has already rallied on anticipation of the news many times.
When the market rallies on news that has already been fully discounted, it often produces a "sell the news" response. The folks that have bought in anticipation of the news, sell and take their gains and there are a few new buyers to keep the rally going.
At least, that is how it is supposed to work in theory.
That sort of first-level thinking makes sense to us, but many market players these days are focused on seeking an advantage over other traders. When everyone thinks that the market will act in a certain way, there will be aggressive traders looking for the exact opposite to occur. They attempt to go long and benefit from poor positioning that leads to panic buying and short covering when the market does the opposite of what most people think is reasonable.
Currently, the argument for a market reversal on this positive news on China trade couldn't be stronger.
- Technically, the indices are very extended and in need of a rest after a nine-week rally.
- Statistical analysis suggests that conditions are strong for some sort of pullback.
- The China news is very well anticipated and not very surprising.
- There is still great uncertainty in the negotiations. Even Chinese vice-premier Xinhua pointed out that "negotiations become more difficult the closer they get to the end."
The argument for a "sell the news" response couldn't be much easier, but the big money traders know that. The folks that zig when everyone else is zagging are pondering this right now and the issue is whether they make it self-fulfilling or they help to produce a squeeze that once again frustrates those that are using first-level thinking. I don't know the answer and won't know until I see how the market acts after the open.
Another complexity to take into account is that there is some great action in individual stocks. I've been writing about this for weeks now, but it has been a very good market for stock picking and there still are some great setups. If there is a pullback on this China trade news, it would only enhance a number of charts. Even if there is some "sell the news" action, it doesn't mean that there will be a market collapse.
The bears have been predicting a market top for quite a while now, but have done a terrible job of timing it. They will be out in full force again proclaiming 'sell the news' -- but this market is all about second- and third-level thinking, so make sure you question simplistic arguments.
Stay focused on price action rather than simplistic logic.