More Homework: Interpreting What You Read about Market Action

One of the biggest traps for the smart investor or trader is the often persuasive commentary about recent market action.

When the Dow had a decline of over 1% last June, we highlighted this problem, calling it the biggest mistake of the individual investor.  As background, readers should go back and look at that article, written when the Dow was under 11,000.  The road was a little rocky for another month, but we all know how it turned out.

What about now?

Today’s Barron’s had a number of interesting insights into current sentiment.  Let us first look at this comment from The Trader column:

"We’re at the point in the mature cycle
where we all know excesses have been built up, and everyone is watching
for signs that point to the end of the cycle [emphasis added]
," says Jeffrey Kleintop,
chief-market strategist at LPL Financial. "The market’s perspective
will get even more short-term from here, and the bull will be a rougher
ride."

Our sense is that this is an accurate reflection of many hot-money managers, trying to time the end of  "the cycle."  Timing this cycle has been going on for three years, spurred by skepticism about Fed policy.  It began with the gradual increase in interest rates from an abnormally low rate.  These guys are shorter than they want to be and reacting to every data point.  Readers might wish to compare  this behavior with that described in our Blackjack article.

Contrast this with Warren Buffett’s advice:  "You can’t get rich with a weather vane."

Barron’s also has an excellent article by Michael Santoli called The Missing Man.  Santoli provides a lot of information about how individual investors have not yet participated in a rising market. Readers should check out the entire article, but here are some key quotes:

Net inflows into stock mutual funds have
been a trickle for most of the past few years, in many months turning
into outflows. This is true even if one includes the money added to
hugely popular exchange-traded funds. The Bank Credit Analyst, a
research firm, points out that household-equity positions as a
percentage of broad money-supply measures have been stagnant since
2004, and are on par with levels from 1995 or 1996, despite today’s
significantly lower interest rates.

That is actual data about the individual investor, not speculation about sentiment.

Richard Russell, the longtime market
commentator and editor of Dow Theory Forecasts, described this
situation in a note to his newsletter subscribers last week. "True, the
little guy may be skeptical, he may be wringing his hands over the
housing situation or the price of a dinner at his favorite restaurant
or the cost of gasoline," he said. "But somehow the big picture, the
stock-market boom, has eluded him. That will not last. The little guy
will not forever resist the lure of the bull market. It’s a question of
timing."

Scott Rothbort, writing for RealMoney, the paid service of TheStreet.com and worth it, (full disclosure:  We now write for RealMoney, although regular readers know we have consistently endorsed this source) has an excellent article where he cites a new interest in the market within his circle of contacts.

We are very far from a top as measured by individual investor participation.  Check it out by looking at a typical CNBC commercial from the bubble era, Stuart teaching his boss to trade online.

Also from the anecdotal-evidence file, in
the week when the Dow first touched 14,000, the prominent ad space on
the back cover of Barron’s shouted, "Short. And Simple," in highlighting the ProShares ETFs that let investors bet against the market.

So we also have individual investors now empowered to short the market based upon "feel" and what they read in the continual pounding from bearish Internet sources.  In another Barron’s article Michael Santoli writes about bullish market predictions at the year’s start as follows:

Those were consensus calls among the
standard sell-side and long-only investment pros at the start of the
year — not, mind you, among the many wised-up, blog-scraping,
doom-inviting macro bears out there who can tell you how many
homeowners defaulted on their mortgages in DeKalb County, Ga. last
week, but not why the Dow hasn’t collapsed.

Conclusion

It is another case where the "smart investor" reading a lot of Internet information could make a big mistake.  The question is where to look and how to interpret what one reads.  Our next installment in this series will cover investment blogs and how to interpret them.

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4 comments

  • gw July 22, 2007  

    I’m looking forward to this next article. (you might as well just put my name in as the guy you’re talking about.) BTW, most of those bear bloggers will say its system liquidity that’s propping up the DOW, all about to come to an end thanks to the CDO massacre of ought seven, the day the music died for Private Equity LBOs. Now, I take a contrarian view to the consensus view of impending financial armageddon (that’s a fun blog, btw, sheesh) but its not an easy place to be with the market whipsaws. Is now the time to put on a hedge? (put options, pair trade?)
    Just for kicks, say Global Alpha states next month that it was up big during July – what then? Would the consensus view turn? (Maybe these FSI turkeys may actually know what they’re doing when it comes to risk management?) Bridge loans get un-hung, credit spreads don’t fly apart, cats and dogs cease and desist the shared living arrangement – and the bkx puts on 10%?
    Or will we have a self fulfilling black swan…(that everyone saw coming from 10 miles away?) This feels more like high stakes poker to me.

  • muckdog July 22, 2007  

    The little investor is still skittish after losing money in Cisco from 2000-2. Doesn’t trust stocks yet. Anecdotally, talking with friends and coworkers who were trading stocks in the late 90’s? They haven’t logged on to their brokerage accounts in years.
    I think the bear argument is always more persuasive than the bull argument. The bear argument runs against the crowd and provides you with the belief that you know something that other people don’t know. It’s alluring.

  • Mike July 22, 2007  

    As an advisor, I’ve had a firsthand look at the skittishness of individual investors. I’ve had many meetings with people who have been earning 20% on the $50k they have in their 401(k), as we’ve been allocating about 35% to international stocks, yet are sitting on three times as much in CDs.
    Most investors are geographically-biased and size-biased. As such, average U.S. investors who’ve been watching the major indices for years have seen little movement. Why? Money has been flowing everywhere else (real estate, international stocks, small caps, mid caps). Now that the large caps are once again moving, I think the average investor will bring his money into the market again.
    The one thing I’m confident the average investor will never do is scale back (or look for undervalued areas) before the market gets extremely overvalued. The average investor is a very, very slow trend follower.

  • james July 23, 2007  

    The problem with expecting the retail investor to return in much of a way is two fold. First, their most recent wrong-way bet was in the residential real estate market. The liquidity of that disaster is limited and many are trapped. As bad as watching CSCO go from $80 to $15 was, most were not leveraged significantly. This is not the case with all the wannabe Donald Trumps. Not only are they sitting on losses but many are likely in a total wipe out situation. The capitulation phase of the stock bear market didn’t occur until July 2002-March 2003. We are still very early in the housing debacle, so I would guess that the return of the retail investor will be very modest.
    The other factor is one of reference dependence. The late 1990’s was a generational bubble in the stock market, just as the housing bubble is the same in that market. To use what occurred in the late 1990’s as a point of reference as to what “normal” bullish participation from retail is not wise in my opinion. The fact is, it is unlikely for retail investors to behave in that way again until we have a generational turnover to the point where the lessons are forgotten.