Don't Cry Over Spilled Coffee

By Susan C. Walker

It’s nearly impossible to find any bargains on airfares this summer, because airlines are downsizing their airplanes and raising prices, which forces customers to pay dearly for being packed in like sardines and accidentally spilling hot coffee on their seat mates. So maybe we should forget that dream vacation and use the money to buy a cheap stock or commodity instead.

Rather than spilling that coffee, take a moment to look at it as a commodity. “Coffee’s price was hot when it topped in January this year, and it’s been cold ever since,” says Elliott Wave International’s futures analyst Jeffrey Kennedy. It has dropped from its 2006 peak of $1.2590 per pound to a low this May of $0.9710 cents per pound. Now may be the time to load up on some cheap coffee, says Kennedy, because he sees it continuing in a contracting triangle (that’s Elliott-wave “speak” for a period of range-bound trading) that will result in a thrust up to much higher levels before the end of the year.

It sounds easy to pick up a good deal in coffee or some other financial market. But although it should be no harder than choosing decaf or high test, it’s not nearly as simple as buying your favorite Italian dark-roast from your local retailer for $7.50 a bag, down from the usual $12. You wouldn’t hesitate, would you? No questions asked; you’d buy a case. But an interesting dynamic makes it nearly impossible for traders to capitalize on such good values in the financial markets, as opposed to finding a cheap seat on Delta Air Lines or a good price for some roasted coffee beans to brew at home.

The key phrase to remember is “financial markets are not shoes.” That’s how EWI’s Bob Prechter likes to explain this concept when he points out that the law of supply and demand governs utilitarian economic transactions (“I’d like to buy this pair of shoes that’s on sale.”) but not financial market transactions. “Economists have long tried to cram financial markets into this model, dubbing it the Efficient Market Hypothesis. Even to a casual observer, though, it quite obviously doesn’t fit finance. Prices for stocks do not act like prices for shoes and bread. They race up and down and do not consistently reflect any objectively calculated value.”

The simple explanation is this: people will gladly buy shoes as their price goes down (on sale or at the local outlet store), but they won’t buy stocks or commodities that are heading down in price. Call it psychology, call it following the herd. Either way, we tend to think that a pair of shoes made by Ecco or Johnston & Murphy is still a good pair of shoes at either the full price or the discounted price. Anybody who values these shoe brands is happy to pick them up at a cheaper price, though.

But this same happy shoe-buyer doesn’t think the same way about a stock or commodity if its price is falling, creating a discounted or sale price. In fact, most traders eye such stocks and commodities suspiciously. Conversely, they eye them admiringly when their prices head up. In fact, they decide to buy because the price is heading up. In other words, the stock or commodity seems to have changed in traders’ eyes – it’s a stinker if its price is falling, but it’s a beauty if its price is heading up. That perspective is unlike the perspective on Ecco shoes, which remain a good pair of shoes in the purchaser’s mind no matter what the price – the shoes are simply a better value at a lower price, and more people buy them as their price falls.

In addition, in the world of economics, both the maker of goods and the consumer of goods are trying to make the most of their resources. The producer tries to get the highest price for its goods, and the consumer tries to pay the lowest price. At some point, a balance is found that works for both producers and consumers. How about that Tall, Skinny Decaf Frappuccino you get at Starbucks? It’s expensive, but the company and you both must have agreed that the price is right, otherwise you would be paying less or Starbucks wouldn’t be selling it at all.

In the world of finance where no such balance exists, things are different. In fact, it’s just the opposite in that people who float stock (such as investment bankers with an IPO) act as if they are thinking, “The higher the price, the more shares I’ll offer,” whereas the buyers (investors and traders) are thinking, “The higher the price, the more I’ll buy.” Prechter sums up the difference this way: “Can you imagine buyers of shoes and food behaving in this manner?”

When it comes to finding good values in stocks, it helps to hold onto the idea of buying your shoes and your coffee beans on sale. Think of it as watching the real estate broker for that house you’ve had your eye on for the past six months adding the words ‘Reduced Price’ to the For Sale sign. Would you snap it up at $575,000, down from $700,000? You bet you would. Try to do the same with stocks and commodities. Don’t follow the herd that sells when prices are heading down and buys when prices are heading up. Break away from the herd. That’s the way good deals are found in the markets as well as in the marketplace.

Editor’s Note: Susan C. Walker writes for Elliott Wave International, a market forecasting and technical analysis company. She has been an associate editor with Inc. magazine, a newspaper writer and editor, an investor-relations executive and a speechwriter for the Federal Reserve Bank of Atlanta. She is a graduate of Stanford University.