Why the Media Matters When Investing
September 3, 2012
Any of you who have heard me speak publicly (or just got me going on one of my tangents talking about the markets) know I'm not a big fan of the media when it comes to investing. The media is in the business of selling advertising space. I don't care if you are talking about television, newspapers, or magazines; they make their money by getting eyeballs to look at their product. And they do it without accountability to the end investor.
Most television programs regarding the markets are little better than reality TV. They sensationalize the events of the day to keep you watching. Throughout the day, they try to explain every movement in the stock market and often times stoke the fires of fear or greed. I'm often asked, "Why did the markets move down (or up) today?" It's really simple. On down days, there are more sellers than buyers, and on up days, there are more buyers than sellers. I know I'm grossly over-simplifying things, but it leads me to the interesting part of this educational piece.
The "sentiment" of the market is exceptionally important, and the media often times influences this mood. In the chart below, you will see that when more than 66% of the investing population (institutional and retail investors) believes the markets are going to go up, they drop by almost 10% per year. When less than 57% of the investing population believes the markets will rise, the S&P 500 increases at a 10% per annum rate. As the sentiment improves (increasing in the 57% to 66% mode), the S&P 500 increases by 14.7% per annum, as opposed to when sentiment is falling in this same middle mode. Then, the markets fall by 3% per annum. As you can see, the sentiment of the markets matter, but so does the directional movement. We often look for extremes. Look at the extremes in the chart (70 and above, or mid-40's and below). When bullish sentiment is above 70% it is almost always near a temporary top of the S&P 500. The opposite is true when the markets cross below 45% bulls. This normally means you are close to a temporary bottom in the S&P 500.
You can see that earlier this year, the sentiment got up to an extreme of 70.7% before falling off. This means that at the peak of the market in the spring, more than 70% of the investors polled thought the markets were going to continue to go up. At the lows a few months later, only 47.2% polled thought the markets would reverse and go up. In other words, this is a contrarian indicator.
Why do the markets move up and down in reverse of what people think they will? It all comes down to psychology and economics. Investors buy when they feel comfortable and they sell when they don't feel comfortable. Most investors buy almost exclusively based upon their gut feeling. When fully invested in the market, how do you think the average investor will answer the question; "Are you bullish or bearish about the market?" If fully invested, they will answer 'bullish.' But how much more can they invest if their money is fully invested in the stock markets? The answer is that they can't invest any more. As a result, the demand for stocks dries up, and the broad based stock markets drop.
We use sentiment as a means of understanding the broad based markets and the probability of their movement up or down. It is used in conjunction with many other indicators (to be discussed in future educational e-mails). Just realize that running with the pack when investing is a good way of underperforming the markets or worse, losing a lot of money.
As always, I welcome your comments and ideas for future educational posts.
Jeffrey J. Powell
Managing Partner, Polaris Wealth Advisers, LLC
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