Today’s global media is communicating a strong sense of investor pessimism. The falling dollar, soaring oil prices and falling home prices are making financial markets skittish and consumer finances uncertain. But one of the keys to taking advantage of today’s economy is understanding the relationship of such pessimism to potential investment opportunities. It may just be that all of the concern is masking a few golden opportunities for the brave individual investor.
From the days when the world financial markets first started reacting quickly in response to the new global media there has been particular importance of understanding the relationship between economic pessimism and future performances of the market. The relationship is understood better with an exploration of what is called the “contrarian indicator.” This is a fancy way of saying that the successful investor when there is a sense of economic gloom doesn’t go along with the herd, particularly when that herd is all moving in one direction.
Many investors might remember the frantic investor sentiment about ten years ago. I used to go to barbecues and listen to our friends brag about their spectacular success in the stock market. They would report buying intenet stocks with ease, waiting a few brief months until those stocks doubled, then selling them and going on to the next amazing success.
Undoubtedly some of their listeners thought, WOW I should do that, too. But many covetous late comers to the tech and internet stock runup that jumped into the game just as the media and other investors were starting to report a sense of imperviousness to risk and certainty of reward were in for a nasty surprise.
As in other famous runups the late comers to the table became what are known as “widows and orphans.” Widows and orphans is the phrase that the financial industry uses to describe investors who invest into a certain trend, whatever it is, right at the end. Sadly, the term hails from the nosebleed run up in the 1920’s of the Dow Jones Industrial average that attracted the attention at its last gasp of those that could least afford the loss.
The reason that widows and orphans and the other last investors to the game will usually loose out is that when the financial markets finally become so attractive that they lure the last uncommitted investor, there is no longer anyone for sellers to sell stocks – everyone owns them already. That is exactly the reason behind the contrarian indicator: pessimism or optimism reflects what tends to be the opposite reaity in terms of future opportunity left in the market. If the widows and orphans are buying (and the media reporting optimism) you should be selling. If the widows and orphans are selling (and the media reporting pessimism), they the smart investor will be buying.
That means there is certainly room for true optimism in today’s economy. Doom and gloom about many sectors including the job market reveals that the economy has a considerable amount of steam. The reason for pessimism that you might hear at a party is not reflective of what your friends feel will be their FUTURE success, it reflects their PAST success – meaning YOUR FRIENDS HAVE ALREADY BOUGHT STOCKS, and there is no one left to continue to drum up the prices.
There was an eerie parallel to the heyday of internet stocks in another sector of the market a few years ago. Instead of stocks in the summer of 2006, at parties every amateur investor that could take on a second seemed to be talking about the real estate market. Everyone was bragging at the easy money that could be had by buying a house and owning it for just a short time, even second properties that none of them had any intention of using.
And just as there was a proliferation of financial trading shows in the late 1990s on cable, there have been multiple clones on the home improvement channels of programs showing the easy success to be had by ‘flipping’ a house. Of course that universal euphoria in the real estate market was “contrary” or OPPOSITE to what the wise investment move would have been at the time. The height of optimism and easy money in housing reflected just the point at which it was about to turn around.
So what is the lesson for today of this valuable investment indicator? Well the good news is that the contrarian indicator is also very valuable in predicting valuable opportunities rather than market tops. If one looks back to those points in history when no one would have been caught DEAD investing in a financial vehicle, that signaled the exact time that it was as good idea to do it.
Remember when everyone was sure gold was supposed to go to nothing a decade ago? It has tripled since then. Remember when the oil companies were doing so badly in the 1980’s that they sought government bailouts? Well we all know how that ended. With surging prices that if any investor had predicted by acting on the over-inflated pessimism would have brought major returns.
Today there is immense pessimism in a variety of sectors of the financial markets. Supposedly houses will be worth nothing in a few years, so if common wisdom is wrong could suggest that there is value at last in the housing market. The dollar if you listen to some is about to go to zero versus the Euro. This means that while the dollar is low and will stimulate a good deal of activity in U.S. exports it is likely about to turn around.
And of course with gas up there Priuses next year. That might even mean that some of those S.U.V’s are going for bargain prices as investors over react. And this is all believe it or not, very good news – because such spooky sentiment is nearly always wrong. In fact, the markets are said to “climb a wall of worry” on the way to new heights, meaning that if there is caution and hesitancy (unlike during those years in the late twenties before the big crash) it means that the smart money is sitting on their investment capital and it still exists to enter the market and bolster prices.
Certainly, investors should educate themselves about current market conditions and investor sentiment. And if there is reason for caution that should be a factor in any decisions. But ironically, once an investor has that education, if they are brave enough (which is rare) and do the opposite of the common sense wisdom, there are likely some very good opportunities in today’s crises – they are tomorrow’s opportunities. The key is to not just see those bargains later in hind sight.