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The real reason November stocks surged

My MoneyWatch colleague Allan Roth noted how November proved a roller-coaster of a month for the markets. Most notably, the Dow Jones Industrial Average jumped 700 points in the last three days of November to give the index an overall gain of 0.8 percent for the month.

This kind of activity illustrates two important investing lessons (or reminders for those who have read my books or followed my blog).

Surprises

Much of the market's returns are determined by surprises, not simply by good or bad news. A company can experience its greatest quarter ever and still see its stock price hammered simply because the outstanding news still wasn't as good as the market expected. The same is true of bad news: A stock can soar if its company reports overall poor results that were much better than expected.

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The market as a whole responds similarly. In this case, we see the IMF action to provide liquidity to banks on a major scale, addressing the liquidity problem threatening the markets. Also, many economic indicators -- such as consumer confidence numbers, employment numbers and retail sales figures from the past weekend -- were all positive surprises. The market reacted accordingly.

Stage Two thinking

Many investors are simply fixated on what's in front of them. Thus, they exhibit what is called Stage One thinking, or the refusal to see the consequences of decisions and actions beyond the immediate. (For more about this topic, read Thomas Sowell's excellent book Applied Economics.)

Consider the hand-wringing by investors worried about the deficits facing many state and municipality budgets. This fussing inspired pessimism about investing in municipal bonds and even caused some forecasters to provide doomsday predictions of massive defaults.

However, many people failed to ask, "And then what?" as the budget deficits came to light. Many states and municipalities have responded to their fiscal woes through budget cuts, layoffs and the like to get their finances in better shape, staving off the expected wave of defaults.

This same line of thinking is why we saw such a jump in the markets at the end of November. Investors only focused on the problems in front of them, rather than the fact that steps would likely be taken to address those woes. Once those steps occurred, the markets responded favorably.

As you make or change your investments, always keep in mind these two issues. Your plan should realize that surprises will occur and that just because things are bad (or good, for that matter) doesn't mean it will continue that way.

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