This is the second of two pieces designed to answer some of the more salient issues covered in last night's Yahoo! chat. It is meant for readers newer to the way stocks work. Vets may be bored by it. I warned you.
Stock prices contain clues to the future, not the past. At times they can show random patterns, but for the most part they make sense. Let's take a couple of situations and examine what stock prices told us so we can understand the predictive nature of the markets.
Earlier this year, when faced with mountains upon mountains of woe,
stock bottomed. It did not bottom when things were going well at Intel. In fact, it bottomed when there was the least visibility. (Some would say it hasn't bottomed, especially after the funky action courtesy of
, but they are fools, because this has been one of the great moves of 1998.)
. Soon after it said things were awry it drifted lower and then started rallying after several months of pain.
These stocks signaled that the personal computer business seemed to be getting stronger
ahead of when it did.
On the flip side, the oil drillers started rolling over long before oil reached its pitiful lows. They were terrific forecasters of the commodity.
I mention these relationships because I got a ton of questions on my Yahoo chat last night from people who seem baffled by the seeming irrationality of stock-price movements. They want to know, how can airline stocks be going down when the planes they take are full? Or, how can you justify the decline in bank stocks when they are so cheap?
Never confuse the rearview mirror with the front windshield. Stocks go down because something bodes poorly ahead, not behind. Stocks bottom when too much negativity is priced in.
Let's take an example right from this morning's pages. On page C22 in my
there is an article about how
stock jumped about 10% when it reported a falling net-income number. On the surface, this makes no sense at all. Fluor reports a number that looks horrible, yet the stock goes up? What's wrong with this picture?
But as you read on you can see that analysts got
negative on Fluor at what might turn out to be the bottom in its prospects. In fact, estimates had gotten
low for Fluor and it was able to beat those reduced estimates.
That's why stocks bottom. Stocks top out when future estimates turn out to be less likely to be beaten than thought.
Sometimes stocks are plain wrong. They give off false signals. Several times, for example, the OSX, the oil-driller index, attempted to hold the 100 level and ultimately failed. Every one of those attempts was a false move.
But for the most part stocks don't lie. They predict the future with uncanny accuracy. Which is why we can't make a lot of money just looking at the past.
James J. Cramer is manager of a hedge fund and co-chairman of TheStreet.com.
At the time of publication the fund was long Compaq and Intel, though positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Cramer's writings provide insights into the dynamics of money management and are not a solicitation for transactions. While he cannot provide investment advice or recommendations, he invites you to comment on his column by sending a letter to TheStreet.com at