What do Michael Jordan, Turk Wendell, and Steve Finley have in common with the stock market? They all believed their performance was based on certain rituals.

Michael Jordan wore his North Carolina shorts under his Bulls uniform every game. Turk Wendell became known for chewing exactly four sticks of licorice, while he pitched on the mound. He then would sprint back to the dugout after the third out of the inning to brush his teeth. Steve Finley has the habit of wearing a pouch containing mysterious minerals around his neck to ward off injury and slumps.

Two Lies and a Truth

Once every quarter, investors’ attention is closely pegged to the ritual of earnings season. Over a period of two to three weeks, the stock market’s fate is directly correlated to the earnings results of the nation’s biggest players. If you can’t get your hands on the pre-announcement hush-hush, the actual earnings announcements are sure to shed light on the company’s (and often economy’s) health. Seemingly mysterious forces, however, seem to distort the direct correlation between news and prices.

Good does not always mean up and bad does not always mean down. On Tuesday, July 14th for example, Goldman Sachs (NYSE: GS) reported record earnings. The earnings numbers were so outstanding that the Associated Press disclaimed the following: “Goldman Sachs’ $2.7B profit shows firm’s prowess.”

Two hours later, the Associated Press noticed that: “Goldman Sachs fails to excite market; Dow up 27.” Not only was the market flat, Goldman Sacks also remained flat for the day (Tuesday).

Something to Get Excited About

Where Goldman Sachs failed to excite the market, Intel (Nasdaq: INTC) most certainly sent waves of euphoria across the globe. Intel reported quarterly earnings of 18 cents a share, far exceeding forecasts of 8 cents a share. While focusing on the good news (earnings beat forecasts by 125%), Wall Street skillfully omits showing the numbers in their proper context.

Intel earned 40 cents a share in Q4 2005 and 38 cents a share in Q3 2007. The 8 cent forecast reflects an 80% decrease compared to the prior high water marks. Some might consider the 8 cent outlook a low-ball forecast.

A Deeper Meaning

The reaction to earnings reports is usually more deeply rooted than mere excitement or disappointment to a company’s performance. How often have we seen the market tank in reaction to positive numbers, or soar in response to dismal earnings?

Last quarter for example, the market dropped following better than expected results by Bank of America (NYSE: BAC) and JP Morgan (NYSE: JPM). Even though certain earnings reports are powerful enough to influence the market for a day or two, in general they lack the longevity to derail the market from its larger trend.

After forecasting a bottom for the Dow Jones (DJI: ^DJI) below 6,700 early in 2009, the ETF Profit Strategy Newsletter sent out a Trend Change Alert on March 2nd, forecasting a 40% rally, the most powerful rally since the October 2007 highs.

This rally continues to develop regardless of the back ground noise provided by Wall Street’s analysts and their rituals. In fact, the March 2nd call for a market bottom came two weeks before Tim Geithner announced his “ground breaking “Public Private Investment Program (PPIP) and bank stress test. Yet, credit for the initial stages of the turnaround in stocks was given to Geithner, Bernanke and co.

New Highs or New Lows – What’s Next?

With the recent spike in stock prices breathing new life into this rally, it might be most timely to discuss the future prospects of the US stock market. Here’s what the March 2nd Trend Change Alert said regarding the longevity of this rally.

“This counter trend rally will have to be broad and powerful in order to relieve investor's pent-up urge to buy. Nevertheless, keep in mind this will be a counter trend rally, the down trend will resume once the rally exhausts itself. This point of exhaustion is likely to happen at a point where optimism takes over and investors think that the Q1 2009 lows are here to stay.”

Better than expected earnings reports will certainly contribute to a rise in optimism. Headlines reflecting a “worst is over attitude” with the wink of an eye implication that the March lows are here to stay have been popping up for a while. “The World has avoided economic disaster”, says President Obama. “We are on the right path, the stimulus is working”, observes Timothy Geithner. The head of U.S. equity strategy at Barclays sees a 2009 rally and has dropped his bearish outlook.

Don’t Believe the Hype

The list goes on, but its core remains; investor optimism is a bad signal if you are hoping for higher prices. You may compare it to the calm before the storm.

If you take a moment to reflect, you will find that the hype surrounding technology stocks reached a climax right before the Nasdaq (Nasdaq: ^IXIC) and Technology Select Sector SPDRs (NYSEArca: XLK) reached all-time highs in 2000.

Following its ascent to the 2007 all-time highs, over 90% of economist projected further gains ahead for broad stock market benchmarks such as the S&P 500 (SNP: ^GSPC) and Dow Jones (NYSEArca: DIA).

Fear of inflation and even a shortage of certain commodities (Sam’s Club restricted rice sales) drove millions of investors into broad based commodity ETFs, such as the PowerShares Commodity (NYSEArca: DBC) and iShares S&P GSCI Commodity (NYSEArca: GSG).

What was the result? Technology stocks tumbled starting in 2000 and never recovered their lofty levels. The stock market recorded its worst decline since the Great Depression following its run to all-time highs. Commodity prices dropped as much as 75%. You can (once again) buy as much rice as you please.

Only a minority of savvy investors are aware that positive news always appears at the top. Being a contrarian is tough at times. Nobody wants to be the odd-ball out. But being different doesn’t have to be bad. Just think of the nerd in your class. How come nerds end up with the best jobs?

Investment nerds (we call them contrarians), tend to end up with the biggest portfolios because they outsmart, even benefit from the investing masses.

A Clear View

Over the next few weeks, take time to observe how rising prices will result in better news and more positive forecasts. Bearish analysts will become bull converts as the S&P 500 (NYSEArca: SPY), Nasdaq (Nasdaq: QQQQ), and other indexes move towards higher levels.

Of course, more than merely observing the market is required to safeguard your own portfolio. At a certain point, all the good news will have pulled the buyers into the market. When there are no more buyers left, prices can only go down. Once prices go down, all the earnings reports will be forgotten history.

Falling prices will lead to earnings revisions (to the downside of course) and downgrades. This becomes a sell-propelling cycle. The old adage, what goes up must come down, will once again prove true.

Jobs are still being lost, home values are still declining, and banks (NYSEArca: KBE) and financial institutions (NYSEArca: XLF) will have trouble getting their toxic assets off the books. At that time, lower than expected earnings will be announced driving prices down even further.

Perma-optimists will soon experience “Japanese torture.” In 1989, the Nikkei topped at 40,000 and has been declining ever since. A few months ago the Nikkei reached a multi-decade low of 6,994, an 82.5% decline. Another example, closer in proximity and time, is the Nasdaq. After topping at 5,000, the tech-heavy index fell as low as 1,250. Even today, it still trades 64% below its high watermark.

Similar to a soldier in enemy territory, investors need to be cautious in the current investment environment. You can’t prepare to defend yourself if you don’t know where the danger is coming from. The newest issue of the ETF Profit Strategy Newsletter includes a detailed target range (points and time frame) for the end of this rally, along with a target range for the ultimate market bottom.