Reader Nitin pointed to an article in the NYT called “The Crowd Is Restless, but Maybe That’s a Good Sign.”
It deals with contrarian analysis, which simply means that historically the tendency for investors is to be wrong at major turning points. Market tops are reached when there are very few bears left and therefore no money is available on the sidelines to push the market higher.
Conversely, the same happens at the bottom when every bull has thrown in the towel and there is not much selling pressure left. Contrarians follow this approach by focusing on sentiment among investment newsletter editors, who allegedly represent the mood of the average investor.
How can that be?
Very simple. The problem with most newsletter writers is that their views and recommendations are based on their personal “predictions” (some of them short-term) of where the market might be headed. They in essence react as a bunch emotionally no different than the individual investor. The Hulbert Financial Digest has found that the stock market performs better on average after periods when newsletters are bearish rather than when they were bullish.
He argues that currently, the average newsletter editor recommends only a 30.2% allocation to stocks and the balance in cash. This is in contrast to November last year when the Dow was 8% lower, but newsletter editors as groups were recommending an equity exposure of 70.8%. If the theory holds true, the current bull market.
While this maybe interesting, it is not a reliable indicator for use in making buy and sell decisions. Hulbert admits that much and cites several examples. Based on that, it becomes clear that most newsletter advice that is based on predictions is faulty when it counts most.
For example, in early February 2001, the record high bullish sentiment reading was 79.7% after about 1 year into the bear market. Contrarians, who took that as a sell point, were rewarded because the Dow ended up dropping another 33% before the bear ran out of breath. Of course, our Trend Tracking method had us on the sidelines as of October 13, 2000 without having to guess sentiment or making any predictions.
My point is that most newsletters that are based on anything other than tracking cold hard numbers may work well in bull markets, but they’re useless when the bear rears its ugly head.