Magazine Covers as a Contrarian Indicator

Includes: DIA, QQQ, SPY
by: Howard Sun

There are many theories out there regarding where the market is headed. I’m going to define the market as the generic Dow and S&P stock indices. Some economists and analysts predict a quick turnaround in 2009, while others predict a much more dire future.

One simple way for us to make an educated guess is to use magazine covers as a contrarian indicator. The theory is that by the time a market’s success or failure reaches the cover page of a major publication, that market will have already been overbought or oversold. The theory plays don the idea of crowd psychology, whereby peaks and troughs occur when the general population gets in or gets out. Thus, all good news are met with underperformance while all bad news are met with overperformance.

This was recently confirmed through academic research by three professors at the University of Richmond in 2007. Statistical tests performed by the researchers implied that positive stories generally indicate the end of superior performance and negative news generally indicates the end of poor performance.

The most famous contrarian cover is perhaps the Time's “Death of Equities”, which subsequently met the super bullish market in the 1980s and 1990s.

Here is a slide show of some of the magazine covers over the years.

So what does this mean for us as we approach end of the year? Time’s most recent cover related to the economy depicts the following on October 13, October 6 and September 29 respectively. I couldn’t find anything related to the market in more recent publications, as they’ve mostly been covering the election et al.

First, notice how all of the magazine covers aren’t really talking about the stock market, they’re more concerned with the overall economy. Now, looking at the black and white “New Hard Times” magazine with a crowd lined up outside a soup kitchen, we certainly feel a strong tone of negativity. However, the bottom right corner has an article titled “No, this isn’t Depression 2.0 How History Can Help Us Avoid It”.

This immediately makes the tone of the magazine somewhat positive again. This shows that the media remains somewhat optimistic about the future of the economy and the market. The fact that they have a positive spin on the economy, and the fact that they haven’t reported much extremely strong negative views on the market is an indication that there is more pain to be had, according to the contrarian indicator.

Many people, myself included, believe the market won’t return until the latter half of 2009, and the economy won’t prosper until at least 2010. As an investor, this is good news because fortunately I have a large portion of my portfolio in cash (as any prudent investor should do in this environment). I am looking to make value buys as the market continues to get depressed. We’re already seeing valuations we have not seen in decades.

So when exactly should we make the most killing? I’d say when Time reports something along the lines of “The Death Of The Stock Market”.