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Why Barron's Prediction of Dow 16,000 Favors the Bears

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A discussion of sentiment and psychology.

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This weekend's Barron's Magazine cover features the exclamatory prediction of "Dow 16,000!" and depicts a bull (replete with a huge Cheshire cat grin) on a pogo stick bouncing over a fat, slow, and apparently confused, bear. Clearly, the message this cover wishes to convey is: "Have another margarita, bulls! There's nothing at all to worry about!"

If I were still bullish, I'd worry about that. (And it goes without saying that one should never drink more than two margaritas before hopping around on a pogo stick.)

This cover is the lead-in for Barron's latest Big Money Poll, and the following quote is found within:
"The stock market isn't the only thing that has set records this spring. Barron's semiannual Big Money poll of professional investors also is setting a record -- for bullishness, that is. In our latest survey, 74% of money managers identify themselves as bullish or very bullish about the prospects for US stocks -- an all-time high for Big Money, going back more than 20 years."

Barron's has a bit of history with bullish magazine covers, and it isn't terribly encouraging. There are some logical reasons that publications such as Barron's sometimes make great contrarian indicators, and I'll cover these in a moment.

Unlike my column (and many other columns here on Minyanville), publications like Barron's are generally more focused on reporting the past than they are on predicting the future. Of course, this is not to imply any kind of slight against them, or that there's anything wrong with news-based publications -- we have to get our news from somewhere. To be honest, sometimes I'm envious: Writing about the past allows an infinitely higher degree of certainty -- and involves a lot less head-scratching, fewer sleepless nights, and virtually no potential for "getting one wrong" (or criticism about the same, for that matter). As Yogi Berra once said, "It's tough to make predictions, especially about the future."

Interestingly, Barron's Big Money Poll in May of 2007 was quite bullish in tone, and predicted Dow (INDEXDJX:.DJI) 14,000 – and that prediction was featured on the cover in a similar way in 2007. The predicted level wasn't actually too far off, and was reached in October 2007 after a rally of about 6%. We all know what happened after that: The bullish cover of 2007 was a whole lot closer to the top than it was to the bottom.

When market publications that usually stick to reporting the past decide instead to predict the future, there is somewhat of an intrinsic "conflict of interest." Barron's didn't become hugely popular by publishing stuff nobody wants to read -- so by the time they're willing to boldly predict something on the cover, it's at least partially because they feel that cover will make the majority of people want to buy their magazine. Bears obviously don't want to read an article about "Dow 16,000!" People who own equities do. This tells us, in a roundabout way, that "bullish" has gone very mainstream -- and in this way, these types of magazine covers help indicate when sentiment levels are approaching extremes.

The problem, and I've written about this many times, is that by the time everyone "knows" something about the market, it's usually dead wrong. When we're talking about bullishness, there are only so many buyers out there -- and it obviously takes a constant influx of new buyers in order for any stock to continue heading higher. Even if a stock were the Greatest Most Amazing Stock in the World (just as a "totally random example," let's say this amazing stock were, ahem, Apple (NASDAQ:AAPL)), once everyone who wants to own Apple already owns it, then at that point, the share price has nowhere to go but down.

Think of it like an auction where -- unbeknownst to the buyers ahead of time -- there will be 50 of the exact same item auctioned off sequentially, one at a time. Further imagine that no one at this auction knows in advance that there are only a total of 49 buyers present for this particular item. In this situation, the first few times the item comes up, the bidding will be hot and heavy since the majority of buyers are still competing with each other. This drives the bid higher each time, and, more importantly, establishes a psychology of "fair market value" for the item in everyone's minds. Since the price is continually being bid higher anyway, each subsequent auction then commences with a higher starting bid, and the buyers naturally take no issue with this.

There will continue to be some degree of competitive bidding, and accordant price increases, right up until the second-last buyer (buyer number 48) secures his item. Then, with no more buying competition, buyer number 49 will simply pay the high starting bid -- and for a brief moment, this last buyer will actually think he got a "really good deal" because no one bid the item any higher. But trouble starts (seemingly out of nowhere) when the auctioneer tries to sell item number 50, because suddenly nobody wants it at the opening bid. He lowers the asking price -- but still, no buyers. What no one there realizes just yet is that all the potential buyers have already been converted into "owners," so there's simply no one left who's interested in the remaining inventory. The auctioneer looks around in surprise, and drops the price again, but still no buyers step forward. And now a new kind of trouble begins, because at that point, all the people who just bought this item feel like idiots. They're not "happy owners" anymore -- in fact, now they're thinking they probably paid way too much!

The feeling that we got "ripped off" -- or that we own something nobody else wants (especially an "investment" nobody wants!) -- brings up strong emotions. These emotions can be exceptionally powerful when it comes to the markets, because emotions in that arena are tied to our sense of financial security, which in turn is tied to our deepest, most primal instincts for survival (none of us can survive for long without any financial resources!). As a result, when the above analogized situation occurs in the stock market, it can actually generate an outright selling panic. The panic psychology is further compounded by the fact that equities have absolutely no practical use whatsoever in the physical world. You're essentially buying a really fancy piece of paper, solely because you're hoping you can sell it to someone else for more than you paid for it. This "greater fool" psychology makes the stock market much more emotion-driven and volatile than the markets for most physical items. In any case, once a "no more buyers" situation is reached, the asking price will have to continue dropping until such a point as either new buyers find the lowered price attractive, or previous sellers find it attractive once again, at which point a new price floor can be established.
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No positions in stocks mentioned.
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