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If You Like to Lose Money, Follow the Crowds


Why the market isn't nearly as bad as you might think.

People say to me all the time, "So you are bullish. Give me one reason why I should also be bullish." Although it is usually tough to answer such a complex question in a short manner, when it comes to being bullish on stocks, I don't think it's really that difficult. The main reason to expect continued higher equity prices is because so many people don't expect it to happen.

Looking back at the history of just about any market shows that assets pop during euphoria. During the 1600s, Europe had what was widely considered one of the first ever speculative bubbles in Dutch tulips. Tulip mania, as it is now known, showed just how out of whack prices can get during a mania. History says single tulip bulbs would sell for many multiples over the annual income of very skilled craftsmen. Other famous 'manias' include the South Sea Bubble in England in the early 1700s, and the Mississippi Company around the same time in North America and the West Indies. Fast forward about 300 years, and we had the Internet bubble of 2000. There are other multiple examples of bubbles and extremes in sentiment from the 1700s to the Internet bubble, as well. But my point is mass hysteria has been along for the ride for a long, long time now. As traders, it is important to remember that crowds indeed are nearly always wrong at the extremes.

For example, the Wall Street Journal published a bullish article within days of the ultimate peak in '07 titled "Exorcising Ghosts of Octobers Past." It focused on how crashes like '87 were a thing of the past. We all know what happened over the next 15 months.

The flipside to a bubble is when things bottom at despair and everyone sells. The thought that the asset could ever go up again is simply ludicrous. March 2009 is a great example of this. The exact day the market bottomed in March 2009, the Wall Street Journal published another article titled "Dow 5000? There's a Case for It." Take note that the Dow (^DJI) was actually trading near 6,500 at the time, so that was quite the bearish call. I'm not trying to call out the Wall Street Journal in these two examples, as nearly everyone had similar views. They just did a good job of describing what the masses were feeling during these two important times.

Now the logical question is, what does this history lesson have to do with stocks right here and now? Well, we are seeing something that I'm not sure we've ever seen before. We have a market that is up more than 100% from its lows back in March 2009, yet if all you looked at is the overriding sentiment, you'd think we were closer to a major historical low. This is incredibly powerful from a contrarian point of view, and bodes extremely well for higher prices the rest of this year, if not even further down the road.

One indicator really hits home as to just how hated this bull market is, and that is a survey Bloomberg conducts that looks at the average recommendation for stocks from US chief strategists at Wall Street firms. The recent percentage is all the way down to just 41%. Incredibly, the prior reading was 51%. This is more than a 20% drop in about a week! Also, allocating just 41% to stocks is the lowest reading in the 15 years' worth of data Bloomberg has compiled. Lastly, the allocation to bonds is all the way up to a record high of 39.8%. The last time it was this close was -- you guessed it -- March '09, when it checked in at 39.1%.

So think about that for a second. Major Wall Street strategists are the most bearish they've been on stocks in 15 years, yet prices aren't all that far away from record highs. If the past 400 years of history is our guide, you want to buy when everyone else is selling or can't even fathom the idea of being a buyer here. This might not seem like the popular stance, as probably everyone you talk to tells you all the reasons to avoid stocks right now. But you can just look at a tulip and smile, knowing that following the masses is a good way to lose money, and staying long this bull market is one of the safer bets out there.

This article by Ryan Detrick originally published on Schaeffer's Investment Research.

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Twitter: @schaeffers
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