U.S. Treasuries continued their recent sharp plunge, perhaps encouraged by
this week's Barron's cover story. Below is another analyst who reached the
same conclusion yesterday, too late to benefit from the strong collapse just
since Wednesday morning:
http://www.dailywealth.com/archive/2009 ... jan_05.asp
It would not be surprising to see a market dip in anticipation of a supposedly
poor earnings season which will "officially" begin next Monday (January 12, 2009).
The actual earnings should produce positive surprises no matter how bad they are;
it will be a classic case of sell on the rumor, buy on the news.
There are many people out there who call themselves contrarians.
However, their reasoning is generally far from sound-and most certainly far
from contrarian.
A true contrarian looks to see what the most knowledgeable people in the
financial markets are doing, and contrasts that with what the least informed
participants are doing. If there is a sharp divergence between the two,
then that is where opportunity lies.
As a simple example, the popular media and amateurs were dumping coal-mining
shares in the summer and autumn. KOL, a fund of such shares, slumped from
more than 60 dollars per share to less than 10. One analyst after another
talked about how President Obama would enact tough environmental controls on
various extraction industries.
Amateurs dumped coal shares in the third quarter and early fourth quarter of
2008 out of disappointment over their sharp collapse, and from media
brainwashing. Hedge funds unloaded since they had bought these shares at or
near all-time highs using borrowed money, and had forced redemptions at the
same time they were forced to repay their loans. Others sold because they
believed that hedge funds would continue to depress the market-monkey see,
monkey do.
However, top executives of coal-mining companies were buying at a rapid
clip. They had been equally heavy sellers near their June peaks, so they
were trading cleverly on both sides to capitalize on these extremes.
Identifying this situation is a typical case of being a true contrarian.
One example of a phony contrarian is a certain person who ranks newsletter
writers. He concludes that if, say, 65% of such writers are bearish on a
particular sector, then it must be correct to be bullish. Or if the
bullishness of gold analysts rises from 30% to 60%, then he concludes that
it is time to turn bearish on gold.
This is a travesty of proper contrarian logic. When the public is becoming
increasingly excited about a particular sector, it is normal for bullishness
to increase significantly. However, this most certainly does NOT mean that
it is correct to turn bearish!
If you sell something short because an increasing percentage of the public
is turning bullish, then you deserve to get badly burned and you probably
will suffer that fate. When public bullishness increases from 30% to 60%,
then it will almost always extend to 80% or 90%, or even higher. Remember
that the final phase of any major rally is often vertical in nature.
Only when the bullish percentage becomes its highest in several years-or
ideally in several decades--does it make sense to take a contrary stance.
Even then, you should only do so if corporate insiders are doing the same;
if there has been a sharp vertical move in either direction to confirm that
amateurs and hedge funds have exhausted their resources; and if other
reliable indicators are confirming this action.
I always distrust sentiment indicators and similar forms of analysis-since
they tell you only what people are saying, not what they are doing. If
people are saying one thing and doing another, then actions always speak
louder than words.
As a simple example, a few years ago there was very heavy insider selling by
the top executives of Countrywide Financial (CFC) and Toll Brothers (TOL).
Meanwhile, these executives appeared frequently in the media to say how
confident they were about the prospects for their company and their
industry.
We know what happened with housing in general and these companies' share
prices in particular. What these corporate insiders were doing meant
everything-what they said meant nothing.
During the Great Depression, dictators were emerging all over the world, as
often happens during a severe economic contraction. Middle-class Americans
were routinely asked during this time by pollsters if they were bullish or
bearish on the stock market. Wanting to appear as patriotic as possible
when these despots were a real threat, they almost always stated that they
were strongly bullish.
However, most of the same people were afraid to actually buy stocks with
their own money, due to equities' extreme volatility during this period.
Many talked a bullish talk-but very few could bring themselves to walk the
bullish walk.
In early 2000, numerous analysts went on record as stating they were bearish
on equities due to the Nasdaq bubble-but as fund managers, they continued to
heavily weight equities in their portfolios! They acted bearish on TV, but
they didn't have the guts to actually invest bearishly. Almost none of
these allegedly bearish analysts actually sold short. Some false
contrarians incorrectly concluded that the pervasive bearishness meant that
stocks would continue higher, and of course they paid dearly for their
misguided deductions.
In this week's Barron's and in other recent publications, there has been
close to a consensus that U.S. Treasuries are a very bad investment at this
time. However, most of these same analysts are keeping a significant
percentage of their clients' money in U.S. Treasuries "for the sake of
diversity", or for some other fatuous reason. That is why an apparently
consensus viewpoint can often come to pass-since people are not putting
their money where their mouths are.
While I follow various sentiment indicators, I only use them when they are
at multi-year extremes-and only then as confirming rather than primary
indicators.
VXO and VIX are truly valuable because they show you what people are
actually DOING, not what they are SAYING. If people are actually willing to
pay five times as much to insure their portfolios against a continued
decline, and if this price represents a 21-year high, then people really are
incredibly bearish, no matter what they say. This translates to VXO near
100 and a powerful buying opportunity as we experienced in October and
November 2008.
Similarly, when VXO and VIX had barely budged from October 2007 through
August 2008, then you knew that even though the media and the public had
allegedly turned more bearish, it was only for show. People weren't acting
more bearishly. They weren't willing to pay a penny more for portfolio
insurance-and so they were really bullish and eager to buy on dips. This
translated to a great short-selling opportunity and so it proved to be.
With an indicator like TRIN which shows actual buying and selling pressure,
it is only useful when it is at a rare extreme. I often see commentary on
the internet saying that since TRIN has been rising for such-and-such a
period of time, or it has crossed above or below some kind of moving
average, that it supposedly has some implication regarding future price
behavior. This is complete nonsense.
Even with TRIN is twice or three times as high or low as its historic
average of 1, it means nothing. Only when TRIN exceeded 10 on December 1,
2008, which was its most extreme close in several years, did it have any
real bullish contrarian implications. Similarly, only an incredibly low
extreme reading would be bearish.
Sometimes the most important contrarian indications occur not in the
financial markets, but in daily life that at first glance may not appear to
be closely correlated with finance.
For example, women's fashion has one of the most reliable correlations with
future stock market behavior. For decades, major market peaks have reliably
correlated with bright-colored, skimpy dress and clearly visible knees,
while major bear-market bottoms have inevitably been accompanied by
floor-length clothing and predominantly dark colors.
Outrageous public behavior is a very reliable signal of a long-term
bear-market bottom. People climbed light poles in 1932 and sat there for
hours; it was all the rage to eat raw goldfish in 1949; while streaking was
amazingly popular in 1974. I have no idea what bizarre activity will occur
in 2010 or 2011, but until it becomes widespread, it's too early to buy
stocks! If we don't get this kind of weird activity in 2011, then don't
conclude that it won't happen-conclude instead that the stock market is
still far from its ultimate nadir. Remember that those who believed a year
ago that we would not have a Presidential cycle low were severely punished.
The world changes, but the financial markets remain the same.
The fact that we had no widespread bizarre behavior in 2008 means also that
the 2010-2011 bottoms will have to be significantly lower than their
respective 2008 nadirs for nearly all general global equity indices. This
does not imply that 2009 will be a bad year for the stock market-we will get
a powerful rebound over the next half year or more, precisely because it
will make the next bear market that much more severe in percentage terms.
