Can Everyone Be a Contrarian?

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Good morning. One of my absolute favorite Wall Street-isms is "Something that everyone knows isn't worth knowing." The idea here is that by the time the proverbial "everyone" is aware of something relating to the stock market, it usually means that "everyone" has already acted on the input in question. It is for this reason that the action in the stock market will oftentimes defy logic.

Long ago, this line of thinking also created the concept of contrarian investing. The strategy is to first identify when ideas/concepts/drivers become overly popular and then to move your portfolio in a direction opposite of the prevailing groupthink. The idea is that by the time every Tom, Dick, and Harry is able to quickly rattle off the reasons behind the current trend in the market, that trend may be about to end.

This also is where the idea of the "smart money" and "dumb money" originated. In short, it is generally accepted that it pays to follow the moves the smart money is making and to simply ignore popular opinion. I'm sure you've all seen the studies showing that the public tends to buy at the top and sell at the bottom of major moves. As such, hordes of analysts now scour every type of input imaginable to ensure that when the public becomes enthralled with a trend; the "smart money" is ready to go the other way.

But my issue here is really two-fold. First, it is a proven fact that both trend-following and momentum investing are valid approaches to the stock market game. Thus, if you choose to be a contrarian just for the sake of being contrary, aren't you going to miss out on the really big moves in the market? For example, would it really have been wise to get long the stock market in September 2008 because "everyone" was too negative? And was shorting tech stocks really the way to go in early 1999?

No, the trick is to be contrary at the END of a move - not during the move. And in my experience, at the ends of really big moves, nobody sees them coming.

Second, by the very definition of the term, everyone can't be a contrarian, can they? And yet, every time I turn on the T.V. lately I hear about some genius, "fast money" type who is making a move in his portfolio because people are too bearish, or too bullish, or too complacent, etc. In fact, CNBC reported on Tuesday that negative sentiment among hedge funds had jumped to 42%, which was up from a recent reading of 27% and was apparently the highest reading of negativity in a year. This report prompted one trader to say that he was covering his shorts and looking to go long.

But wait a second. Wouldn't this rather elite survey of hedge fund managers be considered the "smart money?" As a whole, while the hedgies do get embarrassed from time to time, the asset class still beats the pants off of the mutual fund industry, the pension managers, and the general public. So, it occurs to me that this report stating that a whopping 42% of sophisticated managers are bearish isn't exactly a reason to "go the other way."

In fact, I'm of the mind that this desire to be contrary just for the sake of being contrary was at work Tuesday afternoon. Yes, it is true that Ben Bernanke's letter saying that the U.S.'s exposure to Greece, Ireland, and Portugal is "really quite small" likely led to some short covering. And the simple fact that the recent ISM reports do not show that the economy is in recession at the present time may be enough to cause some longer-term players to put money to work into any and all declines. Oh, and word that things are going well at BMC Software may have triggered some buying. But with Europe diving something like -5% in two days, does it really make sense to be a contrarian?

There are two key points to this morning's missive. First, for anyone looking to play the contrary sentiment game, it is important to understand that in order to consistently profit from sentiment indicators, one must wait for sentiment to first reach an extreme and then reverse. Again, just going contrary to the trend makes no sense at all. And second, the time to truly be contrary is when the crowd is clearly one-sided. As such, I'm a little surprised by all the "fast money" types who believe they are contrary because 42% of hedge fund managers are not optimistic about the outlook for the stock market. So, if you want me to get contrary, call me when that number hits 70%!

Perhaps the thinking here is that traders don't want to miss another bottom like March 9, 2009. But back then, the sentiment was TRULY extreme as just about everybody was SURE the sky really was falling and many stocks sold for less than the cash they had on their books. But at the present time, we have a decline that is being driven by the fact that the economies of the globe are slowing. And the bottom line is this is NOT what we were seeing in March 2009. In fact, I'm going to argue that what we're seeing right now isn't even the same as we saw last summer. But perhaps I'll be wrong. And if I am, then I'm confident my indicators will convince me to change my tune :-)

Turning to this morning... The big news comes from Germany where the constitutional court upheld the legality of the Greek bailouts. This, when coupled with the U.S. simply ignoring the big declines in Europe on Monday, has triggered a sigh-of-relief rally in the global markets. And with traders now expecting Obama-nomics to push a $300 billion jobs package, the battle cry today is "It's ALL good!"

On the Economic front... There is no economic data scheduled for release before the bell today.

Thought for the day... Do you think to say "thank you" for the good things that happen each day?

Pre-Game Indicators

Here are the Pre-Market indicators we review each morning before the opening bell...

• Major Foreign Markets:
  • Australia: +2.46%
    
  • Shanghai: +1.84%
    
  • Hong Kong: +1.71%
    
  • Japan: +2.01%
    
  • France: +2.41%
    
  • Germany: +2.81%
    
  • Italy: +2.91%
    
  • Spain: +2.87%
    
  • London: +1.73%
  
  
• Crude Oil Futures: +$0.88 to $86.91
  
• Gold: -$38.40 to $1834.90
  
• Dollar: higher against the Yen, lower vs. Euro and Pound
  
• 10-Year Bond Yield: Currently trading at 2.015%
  
• Stock Futures Ahead of Open in U.S. (relative to fair value):
  • S&P 500: +12.45
    
  • Dow Jones Industrial Average: +101
    
  • NASDAQ Composite: +20

 

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