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Disbelief Drives the Market Higher - Investor Sentiment as a Predictor

Dec. 27, 2010 2:15 PM ET
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With so many individual investors as well as so called "gurus" predicting another crash, there is little chance it is going to happen. The market never makes the majority right. The government is creating another bubble....

Apart from the economic debate on where the country is headed, there is a great tug-o-war going on right now between institutional investors and individual investors, aka the public. On the one hand, institutions continue to be very positive and have been in this market since the rally began. On the other hand, individual investors continue to be pessimistic even though stocks are making new cycle highs, rates are ridiculously low and the economy is showing some signs of life. Almost everybody I talk to is measurably pessimistic on the economy and the stock market somewhere between “run for the hills” and “better bury food and ammo in the backyard.” Thus, most individual investors have missed this rally awaiting Armageddon.

This is clearly the result of emotion as part of investing. Removing emotions from investment decisions is critical. Institutions do it, and therefore typically outperform individual investors by a large margin. Unfortunately, we as individuals are naturally fraught with emotion which always clouds clarity of thought with regards to the two most sensitive issues: Love and Money. After all, who can say that they have never made an emotional decision in love that just didn’t quite work out the way we thought it would. Whether most people would admit, it works the same for investing – the individual investor is always wrong.

Now, I’ve written for many moons now on the positives in the market. How low rates (don’t fight the Fed), a powerful trend (the trend is your friend), strong earnings (and getting stronger) and no inflation will propel the market higher. All to no avail. People just don’t trust this market. Sure, my clients trust my judgment and they have been well rewarded. However, deep down, most feel like the bottom will be pulled out from under them again.

That, simply put, is negative investor sentiment, and investor sentiment is perhaps the most powerful contrary tool in investing. When the public is bearish, as they are right now, it’s safe to be in the market. When they’re bullish it’s time to get out, and believe me, when the public turns positive, you had better run for the hills.

Naturally, no one knows when this will occur. But there is one thing I am certain: with so many individual investors as well as so called “gurus” predicting another crash, there is little chance it is going to happen. The market never makes the majority right. The government is creating another bubble to combat the economic crises, and with low rates, strong earnings and no inflation, there is more upside left. Sure there will be corrections, as we are overdue for one now. However, continued government stimulus will have the same effect as Viagra. It won’ be eternal, but the continued stimulation will be fun while it lasts. As the market rises it will gradually lure in even the most bearish investors much like the singing sirens in Greek mythology. Only then will the party be too crowded. Of course when the Fed stops stimulating, all bets are off!

Participating in this market is a dangerous as ever, but it is imperative for long term financial success. You must be invested, but only correctly. We are in the midst of a bubble, so you need to know how bubbles work. You can’t just sit in cash earning nothing on your money. Inflation and taxes will eat that away. You also can’t just sit in an old fashioned buy-and-hold (buy-and-hope) portfolio. You must be tactical, which fortunately is what we specialize in, and take advantage of what the market gives us when it gives it to us.

Click to read: How to Invest in Bubbles

Click to read: 6 Steps on How to Play this Market

It is understandings like these that make it so hard to manage your own finances. Removing the emotion from investing is much easier than it sounds. That’s why it’s so important to work with someone that knows what they are doing and have a good track record through both good and bad times. Be the expert or hire one!



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

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