……Take a moment to visualize the pervasive atmosphere of 2007. Predominantly good news and overly optimistic news coverage made the future look bright. The Dow Jones (NYSEArca: DIA – News) crossed 14,000 for the first time ever, producing the general consent that the bull market was here to stay.
Rather than giving the stock market credit for executing the bait-and switch game to perfection, it would be more accurate to point out that investors simply have not figured out how to interpret the signals of their peers. How so?
Broad market indexes such as the S&P 500 (NYSEArca: SPY – News) serve as a composite barometer of investors perception. In fact, the stock market is the most accurate reflection of perceived value. Any stock is only worth as much as investors are willing to pay – the perceived value.
The perceived value rises along with positive news and declines along with negative news. News-induced buying/selling further intensifies price extremes. Perceived value is always highest at the top and lowest at the bottom.
$100/share for a dot.com company with no earnings – which drove the Nasdaq (Nasdaq: QQQQ – News) and Technology Select Sector SPDRs (NYSEArca: XLK – News) to all-time highs – might be just as inappropriate as $5/share for GE (NYSE: GE – News), the oldest and only original DJIA component. Nevertheless, that’s where supply and demand met to determine the price.
Investor’s perception is driven by investor sentiment and news. Investor sentiment is probably the most treacherous force on Wall Street as it is the stock market’s closest ally in bait-and-switching investors out of their money. Optimistic sentiment often signals a top while pessimistic sentiment can be indicative of a bottom.
Case in point: According to Hewitt Associates, stocks made up 69% of 401(k) assets at the market’s all-time high in 2007. As the stock market bottomed in March 2009, stocks took a back seat to bonds and cash for the first time ever. Only 48% of 401(k) funds were allocated to stocks in February ’09.