"It is easy in the world to live after the world's opinion; it is easy in solitude to live after our own; but the great man is he who in the midst of the crowd keeps with perfect sweetness the independence of solitude." ~ Ralph Waldo Emerson
Before I begin with the portfolio structure portion of my Where to Invest 2009 series of posts, I thought it fitting to discuss a non-quantitative, non-scientific perspective of investing -- market sentiment.
I can't help but think we are almost at the complete opposite position we were two years ago -- a time when the "easy forecast" for a new year (2007) by media pundits, economists and most financial bloggers was for higher stock prices; market sentiment (feelings and emotions of investors and financial market participants) was blindly optimistic; and an unfolding of (and end to) a healthy bull market and easy credit environment was difficult, if not impossible, to see...
For today's post, I would like to take you back to January 2007, when I wrote a post titled, "Nary Quite Contrary." Here are a few poignant points from that post two years ago:
After pouring over all of the forecasts for 2007, I do not recall seeing a single one that is negative on the economy, its outlook or the direction for stocks.
...but I do believe that the current overwhelming optimism over the direction for stocks sends the signal that the end of this Bull Market is closer than many of the talking heads will openly say.
As of November 2006, Margin debt was around $270 billion, which is just short of the record set in the year, 2000. Think along the same lines as your neighbor who moved in two years ago and used a three-year "interest only" adjustable rate mortgage to buy more house than he can afford. It's the kind of risk that may not be financially sustainable and it typically points to troubled times lurking around the corner, especially when that kind of hungry speculation becomes wide-spread.
I believe that smart investors should not be afraid to take strategic 'baby steps' away from the crowd, given the right signals, even if they appear to look 'foolish' at the time.
If market sentiment was extremely positive two years ago, and we know what soon followed that blind optimism, could we not apply that same logic on the opposite end of the emotional spectrum today? Or could it be that my persistent reliance on logic has an equal potential to be blinding as well?
A post on market sentiment would not be complete without a graphic illustration. Let's take a look at this graph and ask a few more questions to finish our observations today (click on the graph for a larger image, if needed):
In hindsight, I would characterize the unfolding of the credit crisis in August 2007 as Anxiety; and the resumption of bullish behavior to a record on the Dow in October 2007 as Denial, which largely extended, but slowly diminished, into September 2008, when real Fear dominated market sentiment. I believe Desperation and Panic followed in October 2008, extending to November 2008...
Where do you think we are in the market sentiment cycle now? Personally I believe we are somewhere between Despondency and Hope, which is why I also believe we are also at or near the Point of Maximum Financial Opportunity. Of course, market sentiment can fluctuate and it can remain at Despondency and Depression for a long-period of time before Hope gives way to Relief and Optimism.
"It's important to choose not who you think is the prettiest girl, but who the judges will think is the prettiest girl." ~ John Maynard Keynes
The "judges" are the investor herd and it is not prudent to wager against it. To expand on my usage of contrarian thinking, however, I believe that the investor herd, or "the crowd," is "right" most of the time... but not all of the time. The few points at which the crowd is "wrong" are marked by extreme emotion, which I would more specifically define as "blind optimism" or "blind pessimism."
The media also perpetuates this blindness (and helps a contrarian observe the crowd's market sentiment) by choosing the sensational headlines, rather than those of rational perspective. For example the big headline last week was "Most Jobs Lost in 34 Years." This headline is accurate only by the number of job losses, but when measured by percentage, it ranks at a modest 41st in historical rank.
Some contrarians point to the magazine cover indicator, which highlights the media's sensationalized reflection of mass sentiment of the moment, coming from information in the immediate past (remember stock price movement is based upon future expectations -- not past). The image in the right margin is a 1929 New Yorker magazine cover (hat tip to The Big Picture). We all know what followed soon after...
"We must not, therefore, wonder whether we really perceive a world, we must instead say: the world is what we perceive... To seek the essence of perception is to declare that perception is, not presumed true, but defined as access to truth." ~ Maurice Merleau-Ponty
I have observed that the four most dangerous words for an investor are "it's different this time."
Certainly, the economy has broad weakness with several pockets of extreme weakness that will persist for months and, in some cases, for years or even a generation; however, my logical conclusion with respect to market sentiment is that things are not as bad as most perceive them to be and perhaps a bit worse than a very small minority perceive them to be.
As an investor, and as an investment adviser, I will not wager that we are headed for a depressionary environment or Japan-like scenario just as I will not wager that we are at the bottom of a V-shaped stock market cycle. I'll expand on how I will "wager" with investments in the next "Where to Invest 2009" post...
"What the caterpillar calls the end of the world, the master calls a butterfly." ~ Richard Bach
Finally, when I honestly review my inner thoughts, feelings and perspective, I will admit that I am a person who simply chooses to see the silver lining surrounding the darkest of clouds; however, I am also a logical and curious thinker, which has served me well as an investor and a money manager. As such, my only likeness to the investor herd is that I have been "right" most, but not all, of the time...