The Industry Indicator: Buy When the Market Sells

Current economic conditions and recent market action has everyone worried, and rightfully so. In the past few months, I have referenced interesting personal indicators such as the LJ indicator, which measures investor sentiment in La Jolla, California, The Target Rate Indicator, which shows relative Market action in relation to the Target Rate of the Fed since the inception of the Target Rate in 1997, and more importantly, The Investment Rate, which is a proprietary measure of consumer liquidity levels since 1900 through 2030.

I am personally glad that a bearish tone has overwhelmed the market. I think it is well deserved. Unfortunately, the people that are making the decision to sell at current levels are well behind the curve; where were they 6 months ago? More unfortunately, most people buy at the top and sell at the bottom. Avoid this!

This blog comments on this bearishness that I see in relation to a new indicator: I'll call this The Industry Indicator. I have countless contacts in the Financial Services industry, ranging from professional traders, to retail brokers, money managers, and hedge fund advisors; there seems to be a resounding theme in all major Financial Institutions. The theme: "Be cautious here, the Market may decline."

Major brokerage firms like Morgan Stanley (MS), Smith Barney, which is run by Citigroup (C), Merrill Lynch (MER), and the other big boys on the street develop the mindset of the financial advisors that work for them, who in turn advise their clients on their personal investment decisions. I was a retail broker for 9 years and I know that these big firms want their brokers to follow the leadership of the firm. In fact, independent thinking is discouraged. A great example: the unwritten law is that you can't short a stock that the firm has a strong buy rating on, nor can you buy a stock that the firm has a sell rating on. In January of 2000, by the way, these firms had strong buy ratings on almost all internet stocks and there was no such thing as a sell rating (hold was the worst you could get). In fact, many of them had strong buy ratings on each other a handful of months ago too.

Unfortunately, and Wall Street has learned this the hard way in the past handful of years, the firms making these leadership decisions have a top priority to make money for their shareholders first, and that conflicts with the decisions and guidance they provide to their registered advisors. These advisors are trained by the firm to depend on the insight f the firm, and that helps them guide the investment decisions of their clients. If the priority of the firm conflicts with the objective of the client, there's a big problem.

Six months ago, almost every major brokerage firm on the street was bullish with respect to equities. They were encouraging their clients to buy, at the top. The reason is simple: these brokerage firms make more money when people buy stocks aggressively, so regardless of timing, the mindset is to teach their Registered Investment Advisors to always encourage their clients to invest, because that keeps the commissions rolling.

Without a doubt, the goal of the retail brokerage offices of these firms is to help their advisors build businesses, and that means gathering assets and generating commissions to help increase the bottom line of the firm. Making money for the client is secondary. Brokers rarely tell their clients to sell, unless there's something else to buy; they're trained this way. Isn't there a conflict of interest there? What happens when the market turns bearish?

Let's be specific to what has happened over the past 6 months. Also, remember what happened in the internet debacle. Either most of these firms just don't get it, or they just don't care.

Most major brokerage firms missed the sell signals in the market six months ago, just like they did in early 2000. Why? Because they were making money hand over fist, and their shareholders were happy. Keep the clients invested, keep the money flowing, and don't mess with the model!

Have you ever heard your broker say, "if it goes down we'll buy more" or "the market always goes up over time so we should be buyers on dips" or "we'll move the money into a conservative fund to reduce risk"?

On the other hand, have you ever heard your broker say: "we should go to cash and wait, things look risky"? More importantly, if the answer is yes, do they suggest going to cash when the market is at a peak, or when the market has already declined significantly? If they are following the guide of the firm, they are always behind the curve. This time is just another great example.

Resoundingly, they tell you to sell, or get conservative when the market has already fallen. Today's market is a great case in point. Almost every major brokerage firm on the street is cautious. They are not bullish like they were 6 months ago, and they are advising their Registered Investment Advisors that declines are possible. Where were they 6 months ago? I know where I was. But now, my mindset has changed.

Forget the past, though; what about now?

This is where the Industry Indicator comes in. I can't find a bullish brokerage firm on the street. I am personally interested in what Goldman Sachs (GS) is doing with their in house investments, and I have a strong gut feeling.

Goldman Sachs has a different mantra. They want to be ahead of the curve and they guide their clients that way, too. Most other firms may take internal action. We saw proof of that with some Blodget emails from Merrill Lynch in the recent past, but their decisions to advise their Registered Advisors are significantly behind the curve. Why? Is it because the commissions wane when they tell their clients to move to cash?

Everyone is cautious, everyone is nervous, and every broker that I know is having a hard time telling his clients to buy anything now.

Could there be a better contrarian indicator?

Investment Strategies are simple: Buy when everyone is selling, and sell when everyone is buying. If you followed the Industry Indicator in 2000, you sold at the top, and bought when they put sell ratings on everything by late 2002. If you followed it again recently, you sold in the middle of 2007 when everyone was bullish and no one wanted to hear anything that suggested otherwise.

The next question pertains to the next leg of direction. Is it time to buy? Are the big boys bearish enough? Well, I can't find anyone that's bullish. I think that's a good sign.

I just don't see how Wall Street can become more bearish than they already are, and least not with the current economic landscape. They might panic, and there might be a steep sell off, but we're very close to a near term bottom.

With that in mind, make sure that you reference my prior posts on the Investment Rate, because that tells us to expect substantial declines over time; but the market never goes straight down, so my bullish stance is intended to take advantage of the oscillation back towards resistance, then we'll short again.

The next shorting opportunity might be best reserved for the reversal in the Industry Indicator: i.e: maybe we'll wait to short when the big boys start telling their advisors to buy aggressively again.

Comments

[rdial54]

Finally, now you are talking. I was asking my broker about selling and protecting profits in December and got the standard answer. Lucky for me I took some money off the table and I am somewhat in cash. Wish I had sold a lot more in December. Oh well. I will look to get some "bargains" over the next weeks and months.. Can't wait for your next article and the full buy signal.

[Greg in Al]

IMO, too early. Recession is news but we haven't felt the full effect of it. The banking crisis is just getting warmed up. It looks like there is much more bad news to come in this sector. The light at the end of the tunnel you see may be an oncoming freight train. I'll start shopping when the Dow has a 10 handle on it.

[Leser]

Thanks for the great article. I think that all of us non-professional investors need to keep reading great articles like this in "Seeking Alpha". Investors need to understand the principles of investing and only by reading, reading, reading, are we able to balance our concepts with those actions suggested by brokers, if we are still using brokers. I've started Mark Tier's book "The Winning Investment Habits of Warren Buffett and George Soros". Obviously, a person with pennies to invest isn't going to buy up whole companies like they do, but essentially the concepts identified in Tier's book seem to be advice to help anyone develop their own investing philosophy. That's what Thomas Kee's article above does, too, help one to unhook one's way of doing things from the herd mentality and develop one's own way of deciding, similar to what the first reader did here. rdial54 knew to do their own thinking and the best decision came from themselves, not the broker. Good job rdial54 and Klee! Thanks for your advice.

[Leser]

Name of "reader 2" is really "reader 3" here.

[Leser]

And Mr. Kee, sorry, I made a typo on your name at the end.

[GeorgeGorski]

"Buy when everyone is selling, and sell when everyone is buying". I am selectively doing what you suggest. The stock market is truely self correcting, for example, if a gold miner has a 30% power shortage, the market drives down that stock by 30%. It seems some bean counter is ciberspace is figuring out what companies are worth on a very consistence basis. When companies are beat up and down and out due to unforseen events, that is the time to buy. The political pressure and tax losses will ensure those power shortages are short lived. I watch BNN on a regular basis, not so much for the beautiful women, technical info or news, but to study the brokers. It is amazing how many brokers dont know what they are talking about, from an engineering view point. It is also amazing how many guest brokers recommend to callers to sell when their stock has bottomed out. It is also amazing that some of their top picks are those stocks that are at the peak of the bell curve. I study stocks and only listen to a very select few brokers. There is one who picks stocks based on the company value and uses a model price. This guy I can not find fault with and believe most everything he says. I used to be a long term hold investor, but too many day traders and sooth sayers have entered the scene creating volitility in stock prices. I bought Uranium stocks at their peak and will not sell until they recover. They may outlive me. My current strategy in buying stocks that have been beat up unfairly and have high demand resources as collateral. When I fished as a kid during those hot summer dog days, I quickly learned to fish at the dam outflow. There the current was fast moving and dangerous and potential reward was worth it. By comparison, when it come to my play money, I watch news flashes on the TSX listing and then go in and study the company, if the potential looks promising, then I buy. TSX makes sure the new listing is not a slime bag to protect themselves, otherwise they wouldnt list it. Stocks are cyclic, there is a time to buy into refineries, ice cubes, movies, etc. My current strategy is for the short term, I take my profit and move on. That is the only way I will get my portfolio to grow so I can retire someday. My retirement income prtfolio is now above water and is totally within my control. Anybody out their can self direct their investments, it just rquires discipline, study and patience. Have a good day. Calgary George

[usmctpdog]

The big financials are not going out of business and there is nothing but bad news around. The Gov't will only allow this to go so far without intervention as we are now seeing. The market always comes back as history has shown and always the same story sounded is " this is different this time". It is never different. I have not sold anything and infact have been buying alot the names in the news, NLY, MBI, CFC, C, BAC, FNM, FRE and ETFC along with widely diversified ETF's. I have been an investor long enough with recollection of financial catastrophies in the past that rebounded back even stronger in a timely fashion that had people saying "If I had only bought then" that keeps me secure in my knowledge. Even a diversified portfolio has not protected any area this time. When the sea rises all boats will also. I am secure in my decision to buy "on sale" companies.

[Thomas Kee]

I'll summarize my response to all comments by saying this:

DO NOT ENGAGE IN BUY AND HOLD STRATEGIES.

I am a long term Bear, and although the Market poses some great buys, or will very soon, these are NOT buy and hold opportunities. Your mentality needs to change. If you buy and hold anything at current levels you will be dreadfully sorry that you did 5 years from now. However, if you are proactive, and make buy and sell decisions much more frequently than you have been accumstomed to in the past, you will fair well.

I am specifically referencing your long term investments in retirement accounts, and the like.

All of my clients were told in the middle of 2007 to sell all of their longer term stock market investments, to sell all excess real estate, and to sell any business they thought would not do well in an extremely weak economy. From there, a mentality shift to from buying and holding to being proactive takes over. Everyone here should have a look at my automated trading system.

The Investment Rate tells us that the Economy is in for a period of prolonged weakness. The downtrend that it projects is akin to the Great Depression and the Stagflation period of the 1970's. The downtrend of the IR lasts for 16 years. It tells us that consumer liquidity declines every year from this point for the next 16 years.

You can look at it as the cup half empty, or the cup half full. Full = you know what's coming and you can make money from it. Empty = you sit on your hands and get killed while you wait more than a decade to get whole again. Your approach is your decision.

Witht hat, I feel we are near the trough in a down cycle and great buys are on the horizon, then we get aggressive ont he short side again.

Good Trading.

THK.

[cecil]

I agree with the overall message here, but disagree with some of your premises.

First, I was also a broker, for a major wall street firm, so I too know the inside game. You make it sound as if the managers of these firms know full well when the market is about to fall, but greedily advise their advisors to push their clients into buying anyway. This is false on two fronts. Nobody- not managers, not brokers, and not you- knows when the market is going to fall ahead of time. The best anyone can do is make an educated guess and take on the risk of betting against the current trend.

Secondly, the real reason why the brokerage industry maintains a nearly permanent "buy and hold" or "buy more on the dips" posture is only partially explained by greed. It is also explained by the fact that we live in an extremely litigious society, and if a brokerage firm were to advise their clients to sell when everybody else was still buying, and if they were wrong on that market call, their customers would lose money, and lawsuits would start flying in the doors.

Therefore, the potential gain from "doing the right thing" for the customer by advising them to sell, is overwhelmed by the potential pain of guessing wrong on market direction. Prudence therefore dictates that wholesale market-timing should be avoided.

You are right in saying that the brokerage business is all about gathering assets. I would take that further and say that the best way to gather and keep more assets is to perform well for the customer. So that motivation is already built into the process. But brokerage firms do not emphasize this because it involves taking too much litigation risk.

Don't misunderstand me, I am not a defender of the industry. I witnessed the same shameful behavior that you probably did, and the whole system is terribly biased and flawed. But to say that management deliberately screws the customers by giving advice they know to be wrong is giving them more credit than they deserve.

The other problem I have with the article is that you imply that your indicators tell you, with sufficient certainty, when to be in the market and when to be short the market. But you don't offer much in the way of explanation as to how you are able to achieve this. In fact, you make it sound like anyone with half a brain should have known 6 months ago that the market was going to fall. Is it really that easy? Since the ability to predict major turning points in the market is nothing less than the "Holy Grail" of investing, if you really had it all figured out you would be as famous in the world of investing as Babe Ruth was in the world of baseball.

[clue me in]

Do I choose an investment vehicle based on fundamentals and time buy/sell on a technical basis? Does the current level of any investment contain built-in awareness of future public sentiment? Do I give up and go fishing?

[cecil]

Clue Me In,

Don't give up. Before you get yourself all wrapped around the axle over specific and detailed questions like this, why don't you take a step back and get a few fundamental things in order.

For example, what is the goal of your investment plan? And it isn't enough to answer "my goal is to make as much money as possible in the shortest amount of time." People who are saving and investing for retirement have a very different goal than people who are already financially secure and are speculating for the pure sport of it.

Then ask yourself this question: if all I really need is to get from point A (your current net worth of, let's say, $50,000) to point B (a net worth of $1.5 million) and I have 32 years to achieve this, what is the best way to go about it? The best way will always be the way that involves the least amount of risk in order to generate the final result. Taking on any risk above that level is unnecessary and more likely to result in disappointment.

The second thing you should ask yourself is, do you want to re-invent the wheel by trying to become an expert investor, and enter the arena against highly trained, highly skilled, very wealthy professionals? In my view, this is a very low-percentage bet. I would not even think of representing myself in a lawsuit just so I could save on attorneys fees. Likewise, I believe that serious investing is not well-suited for do-it-yourselfers.

Unless you have so much free time, and so much personal interest in becoming successful at investing that you are willing to do whatever it takes to achieve it, do yourself a favor and spend that time and energy instead on finding a professional to do it for you. It will be well worth the cost.

[Thomas Kee]

Cecil:

Managers do not know when the market is about to fall. But more importantly, they don't make any attempt to protect their accounts because the firm makes no attempt to do that either, although the firm might and does do that with their in house trading accounts.

The objective of the firm is to keep the investors inested. That's the root of earning commissions, which is the goal of each and every office. In fact, they are all ranked on the amount of commissions they earn, in addition to assets gathered to generate commissions of course.

Regarding your next point of knowing the turning points, all I can do is tell you what I have been doing int he past, and I've been damn good at it. Listen to my CNBC clips, or, better, just read one of my past seeking alpha posts:

seekingalpha.com/artic...

[gordon]

So, we're closer to a shortterm bottom, so what? Plunge Protection Team is defending $SPX 1270, look at the 5-min chart of SPY on Friday and exactly at 10:30est when "someone" bought 75 MILLION shares of the SPY, reversing the "plunge" 150 pts. Eventually, markets are larger than gov't Socialistic intervention.
All the earnings numbers are way too high, so will be guidance. I see no reason to try and be a hero, especially with the Plunge Group meeting tomorrow ahead of the Fed on Tuesday, followed by quad-witching on Thursday and a 3-day weekend, while markets think they control Fed policy making a 1/2 pt cut a huge disappointment, any good manager would have moved their client mostly to cash 6 months ago.

[BillF]

Cecil, I don't like brokers' idea of what goals should or shouldn't be. There are only two real goals.
Preserve Capital
Make lots of money quickly as possible
I have too many friends that left their life assets in the hands of brokers who had other objectives.

[cecil]

user,

Unfortunately your two goals conflict with each other. The only way to preserve capital for certain is to avoid risk. But the only way to make lots of money quickly is to take risk. So, will your real goal please stand up?

Also, I never presume to know what my clients' goals should be. I coach them about how to figure that out for themselves. Then I advise them on the safest way to get there.

[Thomas Kee]

If you want to learn about the Investment Rate first hand, I am hosting a webinar on the subject this Thursday. You can sign up and listen in if you have interest:

https://www1.gotomeeti...

[Thomas Kee]

Cecil:

I disagree, the way to preserve capital is to control risk. I have an automated trading program that allows you to do that. No overnight risk, the potential to make money in any market environment, and it only takes a few minutes per day. Read more here:

www.stocktradersdaily....

[cecil]

Thomas Kee,

With respect, I understand what you are trying to do for your users, and I have no quarrel with the validity of your approach. I'm just pointing out that most market-timing systems (99% or more) do not work in the long run. If you are saying that your system is in the less than 1% of long term winners, I congratulate you. But I'm awfully skeptical of this kind of a claim.

The problem with market-timing systems is that they depend on assumptions. Assumptions are guesses. Even guesses that are based on what has happened in the past are still guesses. Do you disagree with this?

You may be very dialed in to something that is going on in our markets right now, and you may be creating excess returns for your users. (One wouldn't actually know this unless you provided an audited track record of all your market calls.) But I say that over time, the forces that you are in sync with today will cease to be the main drivers of excess return sometime in the future. At that point, your serial run of luck will end and you will be heaped on the pile of "used to have a hot hand" market timers.

Sorry, but that's just the way it is, and the way it always has been.

[Thomas Kee]

Cecil...

If your timing is off and you control risk you live to fight another day. In fact, you can even switch teams if you want.

[TonyC-SA]

All right, I am much more of a statistician than a broker, but let me point out that the advice of "sell when everyone is buying" is NOT the Buffet strategy and would also leave you out of the most lucrative investments on the planet; such as MSFT, DELL, PG from 1989 to 1999, and GOOG from 2005 up to 2008.

A contrarian position does not unhook you from the analysts at all, it gives you perfect correlation to the analysts!

Buffet's is an unhooked position, and he buys when brokers are neither buying OR selling; he buys ignored stocks/companies that have been and are still generating positive cash flow and have no visible threats to continuing that trend. He buys IGNORED stocks.

Unlike most statisticians, I agree with Buffet that the market is inefficient and we can find long term inefficiencies. I have seen several such examples, and continue to see them. Mr. Kee may have found such an inefficiency with his analysis or indicator, but if his clients are making money, I strongly suspect there is a lot more judgement in his recipe for success than any brain-dead high-school advice like "Whatever they say, do the exact opposite". (Sounds like Jerry Seinfeld's advice to George Costanza!)

No offense intended, Mr. Kee. But you must admit, a lot of short sellers that knew the DotComs were a bubble still went bankrupt years before the bubble popped. And then a lot of people burned by the bubble dismissed the Google opportunity in 2005.

[Thomas Kee]

If short sellers sell short without risk controls they deserve to go bankrupt! Same thing with buyers of stock.

[Flip]

I know many investment professionals in large firms that continue to do the right thing for the client despite what Kool - Aid is being served. It takes wisdom and experience to extract the good data and observations and use this to serve our clients with great idea's and direction. We also protect them from stupid and emotional choices that reduce overall results. Putting cash to work in a declining market feels better than not having any at all. Invest in quality and enjoy the results.

[TonyC-SA]

>> If short sellers sell short without risk controls they deserve to go bankrupt!

Are you now claiming your method is completely without risk? I haven't been to your site, but if it is risk-free I doubt it can return more than 6% or so. Even if we limit the downside to 6% annually, which I think is about the minimum we can achieve and still hit reasonable returns, a ten year bubble is going to hurt like hell, and any firm with a multi-year string of losses in a rising market, bubble or not, is going to be driven out of business. It may not be fair, but investors always drink the Kool-Aid and will assume the firm doesn't understand markets anymore, and nobody wants to wade through ten years of grief just for the principle of sticking to your guns and hoping things change. Ultimately I do believe Buffett is right and value prevails, but we also have whole decades driven by emotion and we cannot ignore that.

Buffett's strategy is to buy companies he'd LIKE to hold forever because he cannot find a plausible reason to believe their profitable performance will change. If such a reason emerges, he sells.

An investor trying a more active approach should still employ the same philosophy -- Bet on the market trends (or individual stock trends), with the risk controls you mention, as long as there is no evidence it is changing, and when such evidence emerges (because your risk controls are being triggered too often) hide your assets in Gold or bonds or whatever until the new trend becomes clear.

[ezrasfund]

Turn the paradigm around and you will see that it can only be this way....

Most people sell when the stock market is at its bottom,

or

The stock market is at its bottom when most people sell.

Most investors buy at the top of the market,

or

The market is at its top when there is the most buying.

It cannot be any other way, which is why informed buy and hold strategies work best.

[rdial54]

Let's all be careful out there. This could be a bear trap. Don't think we are out of the woods yet.

[rdial54]

Use ETF's. Play the ups and downs daily or day to day. S&P rally go with SSO. S&P dips go with SDS. Use it to play the ups when the market is hard hit and the oposite when the market get too enthusiastic. Trend and counter trend. What do you all think?