What Powerball, Stocks, And Contrarianism Have In Common

| About: SPDR S&P (SPY)

Summary

Keep in mind that the higher the lottery jackpot goes, the more likely you are to split the pot with others.

Lottery participation is not linear. Every new dollar increase in the jackpot game after game does not bring with it a set new number of people who play.

The more an investment is talked up (largely because that investment has already moved and made a boat load of money), the more likely you are to split the payout.

"You've got to kick fear to the side, because the payoff is huge." - Mariska Hargitay

We all know that the lottery is random, and that the odds are one in 292 million. Maybe you'll get lucky and win it all, or maybe you'll split the payout because multiple people luckily choose the same winning numbers. But keep in mind that the higher the lottery jackpot goes, the more likely you are to split the pot with others.

Lottery participation is not linear. Every new dollar increase in the jackpot game after game does not bring with it a set new number of people who play. Rather, the larger the jackpot, the more exponential the number of people who play becomes. That means the more attention the lottery gets, the odds of splitting the payout with others actually increases. Meaning if you really want to play the lottery, the best way to do so given the same odds of choosing the right numbers is actually to bet on a jackpot that is high, but not high enough to attract a large number of new players.

And this relates to the stock market how? The more an investment is talked up (largely because that investment has already moved and made a boat load of money), the more likely you are to split the payout among others listening to the same reasons to buy that particular investment. The more people know about a big payout, the more likely you are to split the pot and not make as much as you hoped. There is a high correlation to the amount of attention the Powerball and stock market gains receive from the media and the jump in the number of new entrants who come in afterwards

This is where contrarianism comes into play. Few people pay attention to losing investments. Those who do will often be too scared to buy in after a large drawdown, even though the very definition of "buy low, sell high" is based on those depressed prices that happen peak to trough. Some will argue that if a stock, asset class, or strategy is down, it must be down for a good reason. As we know from several quantitative studies of markets, however, that "good reason" may be either 1) legitimate, 2) random, or 3) based on a cycle that simply doesn't favor that investment. We show the latter point as being a major one in our award winning papers related to predicting stock market volatility. Being a contrarian isn't about going against the crowd. It's about betting on a jackpot which few other players are betting on, so the odds of you splitting the payout are much lower.

Let's apply this to today's market. Ask yourself very simply - where have most people overweighted their portfolios? What is the overarching narrative? Where are most people betting? Likely on the "cleanest dirty shirt" on the global landscape, which is the US stock market. Why? Because Fed policy and the Age of QE, combined with ever faster information flow from the internet has resulted in a similar Powerball mentality among a large portion of the investor landscape. Make no mistake about it - though we may hear stories about investors "selling" US stocks (NYSEARCA:SPY) in this volatility, you can't unwind 5+ years of divergence from the rest of the world in 5+ trading days.

Where does the contrarian look to now? Reflation through a bounce in commodities (NYSEARCA:DBC) and emerging markets (NYSEARCA:EEM), both of which no one seems to want to buy a ticket on. Of course that doesn't mean you buy that ticket right here, right now. But that also doesn't mean you should ignore what on the surface looks like a low payout right now.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.