In any market situation, there are always the structural optimists, or bulls, and the structural pessimists, or bears. These are the people who have a permanent bias in one direction or another. As the recession progresses, the structural bulls notice that the leading indicators have begun to turn up and take heart from this. When the numbers do improve and then temporarily reverse, this solidifies the opinion of the bears, but more importantly it also convinces a significant number of the structural bulls as well. The significance of this "give-up" stage is that it broadens the number of people holding the consensus to the point that expectations of a weak economy and higher bond prices become a forgone conclusion. The question is no longer "whether" but "when and by how much?"
The consensus that forms at a short-term market turning point appears to expect that "the correction will continue." There seems to be an underlying feeling that prices will eventually move higher, but conventional wisdom insists, "Don't buy yet. Prices will become more attractive in the next few weeks." Invariably they do not, and the next leg of the bull market gets underway to the great surprise of the majority of investors. In these instances, be on the lookout for headlines in the financial press predicting a correction. When this becomes a fairly widespread expectation, you can be sure that a major rally is not far off.
The consensus around major tops and bottoms is a much more contagious affair. Instead of headlines and articles expect to see cover stories in major magazines and features on the evening news. In the case of bearish trends, confirmation is often seen in the indignant reactions of politicians. They usually act right at the end of the trend. Do you remember President Gerald Ford's WIN (Whip Inflation Now) buttons that appeared right at the peak of the 1971-1974 jump in the rate of consumer price inflation? Talk of a new era or justifications that "it's different this time and valuations are not important because . . ." abound. We shall examine some of these concepts later, but in essence they all represent signs of major turning points in the markets. Even so, some of them may appear well before the actual price peak, others will coincide with the peak, and some may actually lag a little. Regardless of the actual timing, such signs represent a warning that the true contrarian ignores at his peril.
I have addressed the subject of when to go contrary in somewhat general terms. We now turn to some more specific, practical methods of assessing when a consensus view has moved too far in one direction. As described in Chapter 7, the major problem arises because it is not possible to set hard and fast rules: Forming a contrary opinion is an art and not a science. No two instances are the same in a character sense and no manias or crowd movements end at the same place. Figure 8-1 represents a typical oscillator used in technical analysis. It moves from one extreme to another. A glance at the chart tells us that when the oscillator reaches the overbought and oversold dashed lines, the probabilities favor that the prevailing trend of prices is coming to an end. However, there are some instances when it continues much further, such as the overbought reading in early 1990. Trying to judge when a consensus has moved too far is a very similar matter. What could normally be interpreted as an extreme in crowd psychology can often move to an even greater extreme before the tide eventually turns. With this important caveat in mind, we can now proceed.
Headlines, Cover Stories, and the Media
The role of the media is to report news and opinion, not to make predictions and forecasts. If the media perform their task well, then they should be reflecting the opinions and views of their readers, or constituents. The more widespread and intense the views and opinions, the more prominently they should be featured. We would surely expect to see stories about the stock market featured in the financial press such as The Wall Street Journal. This in itself tells us little. On the other hand, when a feature article on the equity market appears in general-circulation publications such as Time, Newsweek, or U.S. News and World Report, we should take note because the story has begun to circulate well beyond the usual financial circles. It reflects that the general public may be about to imitate the "experts." The interesting thing about such stories is that they invariably occur after a substantial price movement has taken place. The article may explain why prices have risen so much and in a roundabout way will reflect the conventional wisdom, thereby giving the general public some powerful reasons they too should buy. To the contrarian, the appearance of such stories is not a signal to buy; rather, it is a sign that is time to think about selling.
Figure 8-1 The Deutsche Mark and 13-Week Rate of Change as an Example of a Typical Oscillator. Source: Pring Market Review.
When market stories reach the front pages of general purpose newspapers or the covers of magazines, the implications are far greater than if the stories appear in the financial press. Several years ago, I did some research to try to come up with a contrarian media index. The idea was that if a specific story or theme appeared in the popular media a sufficient number of times, then it was likely that the market was about to reverse. Unfortunately, I was unable to correlate such stories with reversals in the markets. Sometimes my index worked very well. On other occasions, there was a huge lag between the cover stories and the market reversal, and sometimes there was no reversal at all. This underscores the point that the formulation of a true and accurate contrary opinion is very much an art form that can only be achieved with much experience and a great deal of creative thinking.
Paul Macrae Montgomery is a stock market analyst based in Newport News, Virginia, who specializes in what we might call "cover-story analysis." In the June 3, 1991 issue of Barron's, Montgomery claimed that there is a significant correlation between Time cover stories and major reversals in the stock market. His research, which begins with magazine issues from 1923, indicates that when a bullish cover is featured, the market usually rallies at an annual rate of about 17% for a month or two and then reverses. Note that the annualized gain of 17% for two months translates into an actual gain of about 3%. According to Montgomery, then, the appearance of the story breaks pretty close to the final peak. On the other hand, bearish covers are followed by annualized declines of 30% for a month or so (i.e., about double the rate of market rises that follow bullish stories). The interesting point is that over a one-year period the market moves an average 80% in the opposite direction to the theme of the cover story.
Needless to say, these examples occur at major market turning points. By the very nature of the situation, it would be unrealistic to expect a widely published story to signal a short-term turning point. To make the cover of a major magazine, the article has to represent news to which more or less everyone can relate. A major stock market selloff or a huge bull market clearly fits the bill. Other examples cited by Montgomery are the famous "Crash" cover story in November 1987 and a feature article on the "Match King," Ivar Krueger, the day before the 1929 market crash. Krueger was featured because he had just lent $75 million to France to help stabilize the currency, and $125 million to Germany to support his match manufacturing monopoly. This high rolling activity is typical of a long-term peak in speculative activity. Just after the Time cover story appeared, the price of Kreuger & Troll's stock plummeted from $35 to $5 within 24 months.
Cover stories sometimes focus on interest rates. In March 1982, for example, an article entitled "Interest Rate Anguish" featured Paul Volcker, then chairman of the Federal Reserve Board. Treasury Bills were yielding 12.5%, but a year later they had fallen to 8.5%.
I have also found the track record of Business Week magazine to be an equally accurate indicator of major market changes. Perhaps the most famous such piece was one entitled the "Death of Equities" in 1977 when the Dow was selling at less than a thousand. Montgomery cites a 1984 cover story warning of disaster in the government bond market (i.e., implying that investors should avoid government bonds). It was, but for those who did not buy, because yields fell from 14% to less than 7.5% within two years. In this instance, the bond market reversed its downward path within a few days of the story's publicati
on, but trend reversals in other instances usually take much more time. If the story seems to fit the overall market environment, you should begin nibbling away at your holdings or liquidating, depending on the signal.
When emotions reach an extreme, we should expect to see an extreme movement in prices in the opposite direction to the prevailing trend. In the 1984 Business Week article just discussed, the report in some places turned into a forecast by saying, "Investors can do little but brace for further depression of the prices of their bonds. . . ." In this instance, the writer was so utterly convinced that prices would decline that he felt it necessary to overstep his function as a reporter and make a prediction. This is most unusual and provided strong anecdotal evidence that emotions had run too far.
In more recent times, the November 1990 cover of this same magazine was right on a contrarian target when it published "The Future of Wall Street" following a sharp market retreat. The article was not only instructive in the sense that it featured a Wall Street story during a bear market. That was bullish in itself. What was of equal significance for stock pickers was that the article was pointing out why brokerage stocks, the principal beneficiary of a bull market, would be under pressure. During the next bull market, brokerage stocks obliged by putting in one of the best performances of any industry group.
Cover stories that do not appear to have any direct bearing on the markets or the economy can also help in discerning the market's mood. Features about the United States or its embodiment-the President-can often reveal how we think about ourselves. For example, Americans reached an emotional high for several months during and after the 1984 Los Angeles Olympic games, a mood certainly reflected in the news coverage. In February 1985, the dollar ended a super bull market and began a terrible decline within a matter of months.
Covers featuring upbeat and confident presidents also reflect a similar mood in the country. In this vein, George Bush was featured on the cover of Time during the summer of 1989. The article lauded him for being smarter and less ideological than Ronald Reagan. The market responded with a sharp selloff. In January 1991, a cover story depicted President Bush as "twofaced," "wavering," and "confused." This also reflected the mood of the country, and that uncertainty also pervaded the stock market. This sentiment had already been discounted by the stock market, which then proceeded to experience a very powerful rally. In effect, if the nation, either directly or indirectly through its elected officials, is reflected in a cover story as ebullient and confident, expect the market to decline. On the other hand, if the story reflects a lack of national confidence and will to tackle its seemingly insoluble problems, expect a rally.
I should add that you should not rely on all cover stories with such precision. Time's famous "Birth of the Bull" cover in the fall of 1982 was not followed by a general market collapse but by a long-term bull market. This emphasizes that one should not go contrary just for the sake of going contrary. It is mandatory to examine the facts and come up with some reasonable alternative scenarios. In the case of the "Birth of the Bull," the economic and valuation conditions were totally inconsistent with a major market top. The dividend yield on the S&P Composite Index at 5.1%, for example, was closer to the historical level of undervaluation than overvaluation. Moreover, interest rates had just begun to plunge and the economic news was very poor-all signs of a major market bottom. The only aspect that did not fit was the "Birth of the Bull" cover. In this case it was being featured because of a tremendous rally on Wall Street accompanied by record volume, not because the consensus had moved to the superbullish camp.
Even when conditions appear to be in tune with a cover story, a rally is not necessarily guaranteed. In the summer of 1991, Fortune featured the CEO of IBM on its cover. This seemed to confirm the general opinion that the company had been going through a difficult period from which it might not emerge quickly. The price of Big Blue's stock had sunk from $140 to about $100 at the time of the article. With a yield of close to 5%, the market had already gone a long way toward factoring in all the bad news. As this chapter is being written a year later, IBM is no higher in price. This is not to say that IBM's stock will not rise but more to underscore that cover stories cannot normally be relied on as exact timing devices. They require patience. The contrarian value investor can afford the time and in this case is being rewarded with a dividend yield that is almost twice as much as the market itself.
We also need to be careful in our cover story analysis when there is very little general news. Somebody has to appear on the cover of Fortune, so if there is very little competition for the front page, a market or economically related story may well creep in by default. The impact is likely to be far less significant under such circumstances.
Thin-Reed Indicators
Cover stories are a high-profile tool put at the disposal of contrarians, but some less obvious ones, in their own way, can be equally as valuable.
A classic example was featured in the November 1990 edition of Investment Vision (now Worth Magazine). The article was written by Contrarius, a pseudonym for Leo Dwarsky, formerly portfolio manager of the Fidelity contra-fund. He made the point that stock groups move in and out of fashion just like styles of clothing. The article featured Campbell Soup, whose stock had quadrupled between 1958 and 1962 reaching a price/earnings multiple of 30 at its peak. In the ensuing 19 years, earnings grew consistently. There was only one down year. This certainly justified its rating as a growth stock even though the momentum of the earnings growth had begun to slow. Surprisingly, by 1981 the stock was selling for about 40% less than it did in 1962. Investors had lost complete interest in the stock.
Dwarsky then tells us of a "thin-reed" indicator that provided a vital clue that the consensus had solidified in the bearish camp. He received a report on Campbell Soup that read as follows: "Campbell Soup-Deleted from Coverage. Investment Opinion: In preparation for an expanded coverage of the consumer area, we are deleting Campbell from our coverage."
That was it. A perfectly good national company that had consistently improved its earnings over the period of several decades was suddenly being deleted from coverage. It indicated that the stock was out of favor with the institutional community. The real kicker was that the consumer area itself was being expanded and yet a key consumer stock, Campbell, was being dropped. Research houses thrive on commissions and if there were no commissions to be gleaned from Campbell, better not to cover it. Needless to say, the stock appreciated by 900% in the next 9 years.
Another form of thin-reed indicator occurs when you read a story in a general-purpose magazine that is highly technical or specialized in nature. For example, a story on stock index futures or options would not be out of place in a financial publication such as The Wall Street Journal. They appear there all the time. However, it would be somewhat out of the ordinary to see such a feature in a general-purpose publication such as Newsweek or Time. Such an item generally indicates that an investment idea that is normally confined to a select number of speculators and professionals now has a more widespread acceptance. For "widespread," the contrarian should read "potential reversal."
Another specialist concept that could fall into this category might be a cross-currency trade. Usually the dollar is traded against the German deutschemark. Consequently, a story featuring the benefits of trading the mark against the yen or the Canadian dollar against the pound would represent a strong thin-reed indicator that the prevailing market trend was about to reverse.
The so-called Ted Spread is another favorite. This transaction involves the simultaneous buying of Treasury Bill futures and selling of Eurodollars. The idea is that, if some financial crisis is brewing, investors will rush to embrace the quality of Treasury securities to avoid Eurodollars, which are an investment of poorer quality. If speculators are able to get in on this trend early enough, they can expect to make some reasonable profits. This is the kind of stuff that is featured quite often in financial publications but only makes its way to general purpose
magazines and newspapers when there is a story attached to it. That inevitably means close to a major turning point. The reversal of such trends in the relative performance of Treasury Bills to Eurodollars obviously has a lot of relevance to the small number of individuals playing the spread but it can also have wider implications for interest rates, the stock market, and the economy. Presumably, if the major players are concerned that something like the Ted Spread is widening, the appearance of the story means that confidence is at a trough and so too should be the stock market.
Other thin-reed indicators may include a story on a relatively obscure market such as lumber or sugar. There is a natural consumer interest if the prices of these commodities have risen. The chances are that they will have reached the peak by the time the popular press has got around to extrapolating recent trends. I remember in the early 1980s seeing a story on the price of sugar being featured on the CBS Evening News. This occurred after a huge run up in the price had taken place. The story "broke" almost to the day of a major peak. It is doubtful whether sugar has been featured on the program since.
Not all such indicators are as timely and useful. In 1990, for example, a gold fund was liquidated because of a general lack of interest in the precious metal. Also several major brokerage houses in New York and London deleted their gold coverage in a manner similar to the Campbell Soup example cited earlier. The gold price did rise for a few weeks after these developments, but not nearly to the extent that might have been expected. By the same token, the price did not go down either, choosing to languish in the $345 to $370 area for the next year or so. In this sense, the thin reed along with the cover story on IBM mentioned earlier told us that these markets were sold out and were a low-risk play. They did not, as they usually do, signal that a major rally was underway.
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