Be Careful with the Contrary Indicators

Monday, December 19, 2005 | 05:34 PM

We’ve been hearing an awful lot of chatter about Bullish and Bearish sentiment lately. It’s a subject near and dear to our hearts, being curmudgeonly contrarians ourselves. But when it comes to Contrary Indicators of either sentiment extreme, we continue to advise investors to exceedingly careful with anecdotal evidence.

We’ve been hearing that “everyone is too Bearish - but the data does not support that. Last week, the WSJ's Justin Lahart asked “Which way is the crowd really leaning these days?”  He found that the crowd is fairly Bullish:

· More U.S. fund managers think stocks are undervalued than overvalued (Merrill Lynch).

· Hedge-fund investors' net exposure to stocks is at the highest level in nine months (ISI Group).

· Sentiment measures show investors feeling more bullish now than they have all year (Ned Davis).

Furthermore, consider the sleight of hand loved on Wall Street to show how “cheap” stocks are: Wall St typically projects the upcoming 4 quarters for S&P500 earnings. At the same time, comparos are made to actual (trailing) earnings. AQR Capital’s Clifford Asness observes this clever trick allows analysts to tout a forward 2006 SPX earnings of $88.59 to show 14.2 P/E ratio. The same math applied to the markets historically (1871-2003) shows a P/E ratio of 11. With SPX 29% over its median P/E, it is hardly cheap.

“No one rings a bell at the top,” goes the cliché. It is much more difficult to find contrary signals at tops than at bottoms. We can look at divergences, money flows, and anecdotal evidence - but that’s hardly as significant as all the quantitative data generated by the panic always seen at bottoms. And, as has been noted before, markets can remain irrational longer than most can stay solvent.

When trying to guess when markets are about to peak, what we are actually attempting (foolish, though it may be) is the anticipation of exactly when buyers 1) run out of cash, or B) undergo a major sentiment shift that changes their investment views. “What is the sound made by a Bull putting away his wallet? Hardly any.

Bottoms, on the other hand, are far easier to recognize. Our favorite Texas expression is “Just wait for the thud the bodies make when they hit the pavement.” For some detailed examples of those “thuds,” see our 2003 report titled Contrary Indicators 2000-2003 Bear Market.

Most investors are better off with quantitative data, and steering clear of the ambiguous anecdotal evidence of the “He said/She said” varieties. We’ll stick with the numbers.

Monday, December 19, 2005 | 05:34 PM | Permalink | Comments (3) | TrackBack (2)
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Listed below are links to weblogs that reference Be Careful with the Contrary Indicators:

» Sneaky Street Conspiracy? from A Dash of Insight
Tucked inside this recent post joining the debate on who is the bigger contrarian, is an assertion that Wall Street is tricking us into thinking the market is attractive when it is really almost 30% overvalued. Barry Ritholtz invokes a [Read More]

Tracked on Dec 22, 2005 8:11:41 PM

» Sneaky Street Conspiracy? from A Dash of Insight
Tucked inside this recent post joining the debate on who is the bigger contrarian, is an assertion that Wall Street is tricking us into thinking the market is attractive when it is really almost 30% overvalued. Barry Ritholtz invokes a [Read More]

Tracked on May 7, 2007 5:01:27 PM

Comments

Interesting comments. Always respect your judgment from your blog and occasional appearances on Neil Cavuto and Larry Kudlow. Yes, I also think it is good to take a contrarian attitude especially now.

Posted by: Ralph | Dec 20, 2005 12:15:17 AM

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