The Top 10 Stock Market Myths Expose, Setting the Record Straight

By: EWI

Not knowing the truth can be hazardous in just about any type of situation, but especially when it comes to your financial future.

To help you decipher market truth from myth, Elliott Wave International put together Market Myths Exposed, a free 33-page eBook that takes the 10 most dangerous investment myths head on and exposes the truth about each in a way every investor can understand. Originally published in 2009, it's still just as valuable as ever. Get your free eBook here.

Here are the first two myths from Market Myths Exposed:

Myth Number 1: Earnings Drive Stock Prices

"The bottom line is earning drive stock prices" -- Investopeida.com. It's simply not true. The flawed notion that profits drive stock prices is something that EWI has discussed numerous times over the years. For one thing, the quarterly earnings reports announce a company's achievements from the previous quarter. Trying to predict future stock price movements based on what happened three months ago is akin to driving down the highway looking only in the rearview mirror. The trends in earnings and stock prices sometimes even move in opposite directions, such as the 1973-74 bear market when S&P earnings rose every quarter as the S&P declined 50%. More recently, earnings have been cycling with stocks, but that still leaves the problem of reporting delays, which leave investors eating the market's dust when the trend changes. To try to get around this, pundits use analysts' estimates of future earnings as a guide. In doing so, however, they are subject to the same herding impulses as investors. As Conquer the Crash puts it, "Earnings estimators are too pessimistic at bottoms and too optimistic at tops, just when you most need the indicator to tell the truth."

Myth Number 2: Small Stocks are the Place to Be

As one headline from earlier this year put it: "Small Firms See Silver Lining in Deflation Cloud." The common refrain is that small caps will score efficiency gains because "they are typically more nimble." But they are also less well capitalized and thus susceptible to price wars, spiraling asset devaluations and tighter credit conditions. "Since the onset of the credit crisis over two years ago, available credit to small businesses and consumers has contracted by trillions of dollars," says analyst Meredith Whitney. She estimates that credit-line cuts to small business are about halfway through, but this estimate will prove overly optimistic. Small business loans are frequently backed by collateral such as homes, buildings, inventory and receivables. As these items decline in value, creditors will not make new loans or roll over old ones, forcing more sales and intensifying the small business person's plight. As we noted in last month's Bottom Line, small-cap shares are "providing downside leadership." They continue to do so, signaling a burgeoning decline for the larger stock market as well as intensifying deflationary pressures.

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