Magazine Covers: The #1 Contrarian Indicator?

by: Nicholas Vardy

Just when things were going so well for Steve Jobs & Co, last week's Economist magazine had to feature Apple Inc. (NASDAQ:AAPL) on its cover. If history is any guide, that's bad news for both Apple and its shareholders. Call it the "curse of the magazine cover indicator." Whenever a company makes the cover of a general business publication, its bull run is over. As Princeton economist Paul Krugman wryly noted, "Whom the Gods would destroy, they first put on the cover of Business Week."

Although Krugman cited Business Week, the Economist has had its own share of flops -- including a cover story in the late 1990s that seriously analyzed the possibility of oil for $5 a barrel. But it's Business Week's famous 1979 cover, "The Death of Equities," that is a textbook case of the media getting it wrong. The Dow Jones Industrial Average was at 800 back then. Yesterday, it closed at over 13,553. But it's hard to beat Time magazine for getting it right (or wrong). Time anointed Amazon (NASDAQ:AMZN) CEO Jeff Bezos as its "Man of the Year" at the end of 1999. The Internet bubble was at its peak and Amazon's stock was near its high of $113. Within 12 months, Amazon closed 2000 under $16 -- an 86% drop.

The #1 Contrarian Indicator: Tested and True

Here's the theory behind the magazine cover indicator. By the time a company's success or failure reaches the cover page of a major publication, the company is so well known that it is reflected fully in the stock price. Once all the good news is out, the stock is destined to underperform. The reverse holds for negative stories.

A recent academic study by three finance professors at the University of Richmond put the magazine cover story indicator to the test -- specifically as it focuses on coverage of individual companies.

The professors culled headlines from stories in Business Week, Fortune, and Forbes for a 20-year period to examine whether positive cover stories are associated with superior future performance and negative stories are associated with inferior future performance. "Superior" and "inferior" were determined in comparison with an index or another company in the same industry and of the same size.

Here's what the professors found. First, there were a lot more positive stories than negative ones for the same reasons that stockbrokers issue more buy than sell recommendations. Second, positive cover stories tended to appear following periods of strongly positive performance, while negative stories followed very poor returns. The companies that received the most positive coverage had, on average, outperformed the index by 42.7%. Those companies suffering negative coverage, in contrast, had underperformed by 34.6%.

The more important question for us is how the stock prices performed after the cover stories appeared. Here, the research supported the use of magazine cover stories as a contrarian indicator. The most negatively portrayed companies managed to beat the market by an average of 12.4%, whereas the outperformance of the media darlings fell to just 4.2%. The conclusion? Positive stories generally indicate that the stock's price performance has topped out. Negative stories often come right at the time of a turnaround.

The study confirms that it is better to bet against journalists than alongside them. It would be easy to jump to the self-congratulatory conclusion that journalists are incompetent. But that conclusion misses the point. Journalists aren't writing cover stories to make investors money. They are writing cover stories to sell magazines. And "hot topics" sell. But it also means that when a company or financial trend is featured on a magazine cover, the chances are that the trend is already widely known, and universally accepted.

If investors misappropriate magazine cover stories as an investment strategy -- well, that's their fault. Behavioral psychologists call this "recency bias" -- the tendency to be excessively affected by the pattern of recent data. "Availability bias" is a close cousin. Behavioral psychologists can trace back all financial manias -- whether the Internet in 1999 or China in 2007 -- to our own, intrinsic, inevitable cognitive distortions.

Rather than rail against journalists, we should understand that these behavioral tics are part of our natural genetic wiring. It's what makes us human -- and not hyper rational homo economicus -- economics textbooks posit. Behavioral tics also explain why markets are inefficient in the short term -- why share prices overreact in both the short and the long term.

The #1 Contrary Indicator: Not A "Holy Grail"

Despite the confirmation of academic studies, the magazine cover indicator is no Holy Grail. And it may be that the very "recency" of the dotcom bust of 2000 overstates its importance. That financial mania was a banner era for contrarian magazine covers.

Why did the magazine cover indicator work particularly well in the dotcom era? The level of consensus in the marketplace was extraordinarily high. And rarely have so many people gotten so many things so exactly wrong. Emotions and excitement clouded judgments. And as always, near the top, the greed crowd grew frenzied. Post-crash, it was the reverse. A fear-induced panic meant that the baby went out with the bathwater -- regardless of price or value. Mob mentality -- when unanimous and fraught with emotion -- is almost always exactly wrong.

China made the cover of Time magazine on Jan. 22 this year. The China ETF (NYSEARCA:FXI) peaked Jan. 3.

Yet here is a caveat. The "contrarian" magazine indicator itself may have become too "conventional." Yes, Cisco (NASDAQ:CSCO), Dell (DELL) or EMC (EMC) were on many magazine covers in 1999 and 2000. But they were on many covers for many years prior to their collapse. The same goes for Apple, and for Google (NASDAQ:GOOG), for that matter. The bottom line? The magazine cover indicator is no Holy Grail -- nor is it that ever elusive "free lunch."