When to Be a Contrarian

I really believe that when economic cycles are at their peaks or troughs, it is very important to be contrarian. Right now, we are seeing various signs that the US economy is at its troughs, and at the same time the prevailing sentiment is bearish. Well, the bullish contrarians, like me, are being bashed frequently. Liz Ann Sonders of Schwab, who is on the bullish camp since early this year, writes:

"Frankly, I've been surprised at some of the reactions I've gotten from investors. It's not just that there are few believers; it's that some of the nonbelievers have expressed their opposition to the optimistic view with such anger … some of it aimed directly at me."

I've gotten the pretty strong reactions from bearish people with one of my bullish posts which was published in Seeking Alpha.

Sonders then quotes Brian Wesbury of First Trust Advisors:
"He notes that many who were pessimistic about the economy and the market earlier this year are going through the "classic five stages of grief: First, they denied that a recovery was going to happen anytime soon. Then they lashed out with anger at those who spotted signs of the recovery. Now, they’re bargaining, admitting the existence of the recovery that they did not see coming, but belittling it. Next, as things keep improving, we can expect them to get depressed. We don't expect acceptance to fully set in until late next year."

Pretty classic to me. What I am saying is that bulls have to stay their course and not be swayed by all the negativity out there. A lot of people sold their shares and raised cash at or near the bottom, and the market rallied 50% without volume simply on lack of supply. It only takes 10 bullish people out of a 100 to push stocks up dramatically as we have seen in the past months simply because there are no shares to sell anymore. Right now, while the ratio of bullish people might have increased to 2:8 or 3:7, too many people are still waiting for compelling data that the US economy has bottomed. They forget that the market is always anticipatory.

From a supply-demand perspective, there are still simply not enough long positions to be liquidated for that 15% to 20% drop some people are looking for. How are stocks going to drop that much when people don't have much to sell in the first place? A lot of people are even short seeing that the market has lost its momentum for the meantime. Vice-versa, at peaks in the economy, everyone is so bullish and their portfolios are so loaded and leveraged that even if they sell a portion of their holdings markets will just crack. How can it continue going up when everybody's cash is already invested?

In the end, I'd rather rely on data telling me how much invested institutions are in the market as an indication of what has already been factored into the market, rather than historical P/E bands based on earnings estimates or other complex formulas that are subjective at most. Actual institutional levels of stock holdings on the other hand are simpler and easily accessible.

For my part, I think we can possibly have a shallow correction (the stage we are in right now), which is part of a bigger consolidation period. For my short-term view on the markets, read my previous call for a range-bound market, and the support levels I have identified for the S&P 500. For my six month view of the markets, read this. Remember that a huge consolidation period can easily achieve what a huge correction does in terms of taking out supply overhangs in the market, making up for the lack of magnitude with duration. Read this article from David Rosenberg entitled: "Mr. Market Has A Full Tummy". Here he brings forth the possibilities of both a large correction and a shallow one. But I do agree with him that the market has run ahead of fundamentals for now... that's why we need time to correct this through a consolidation.

Laszlo Birinyi hits the nail right on the head. He compares the current market environment to the movie "Titanic". He said the movie had no stars and everyone dies in the end... but it was still a big hit!

Comments

[Jasper M:]

Well done!
" really believe that when economic cycles are at their peaks or troughs, it is very important to be contrarian."
This would seem trivially true, but is so often ignored in favor of easier trend following. But trend following reliably fails at major turns.

But, with due respect to Mr. Birinyi, this market has lots of stars (C, BAC, AIG, FNM, FRE) . . . all villains!

Sep 04 04:13 PM

[Kint:]

Good post..it takes a strong stomach to do what you say, but it pays off.

Sep 04 04:55 PM

[Gtarras:]

expect a lot of angry bears trashing your piece!

Sep 04 05:00 PM

[Gtarras:]

great article. what is the best source in your opinion to go about getting the data that tells you how much institutions are invested in the market?

Sep 04 05:27 PM

[adan:]

interesting take, thanks!

my two (diluted) cents worth :-)

1) regarding, "...the market is always anticipatory...." - i like it when it's anticipatory both on the up and down side, which it was not, oct 2007 - early/mid 2008

2) the degree of relentless bullishness i see and hear, on cnbc and other mass media (read majority) outlets, does not give me the same view of % of bears as you see

but i respect your views, and should, or mr market might just want to continue proving itself "recovered" ;-)

Sep 04 05:29 PM

[likbez:]

Good reference to "five stages of grief" which can be more correctly called "five stages of envious greed". Should serve as a warning for those who stayed on the sidelines -- do not jump into the fire: you can be badly burned...

The problem with the desire to ride the rally from the bottom is that it's clear only in retrospect. People who became optimistic in 2008 can attest that.

If this is temporary bottom those who jump for quick profits will repeat 2001-2002 experience (when everybody was convinced that September 11 was "the bottom")

For those 401K investors who stayed on the sideline, I think they did a right thing: missing profits is still a different thing from losing money. I think they still can benefit from wait and see approach for a year or so. BTW bonds provided spectacular returns in 2009, although definitely much less then stocks.

But excessive greed is a bad thing.

Of course traders, especially those who play other "other people money" will disagree.

Sep 04 07:48 PM

[Terence Chan:]

Gtarras,

The figure right now is about 30% of institutions money in money market funds, down from 45% in March, but still off the 11% peak we've seen historically. Also based on past data, markets rally significantly with levels above 25%. You can go to ici.org. There is weekly data of institutional money market assets in their statistics page.

On Sep 04 05:27 PM Gtarras wrote:

> great article. what is the best source in your opinion to go about
> getting the data that tells you how much institutions are invested
> in the market?

Sep 04 11:13 PM