Reverse market psychology

The wisdom of Wall Street has it that the market never hits bottom until the last bull capitulates. In other words, there is no hope of things turning around until everyone has given up hope of things turning around.

If this is true, then this morning’s Wall Street Journal lead story ought to give us hope, because it reports a bleak absence of hope.

“Investors around the globe appeared to be giving up hope and girding for a prolonged recession.”

I thought it’s been crystal clear since last September, if not before, that the “prolonged recession” scenario was the best case. But maybe it’s been looking different to the folks on Wall Street. Maybe that’s why they’re still in trouble?

“Traders said the latest downdraft broadly reflected a deepening sense of gloom among investors. Gone are the days where the mantra among investors was to “buy the dips,” on the belief that when stock prices fall, they’re likely to rebound. Instead, the opposite sentiment has taken hold.

“It’s like an unending nightmare,” says Kent Engelke, managing director at Capital Securities Management in Glen Allen, Va.

So it sounds like the last of the bulls has thrown in the towel. Which ought to mean that we’re at or close to a market bottom.

But here is why this particular strand of Wall Street wisdom always seemed problematic to me. If it were accurate, then some portion of the market would follow it — in other words, some group of investors would always see the general rout and think, “Aha! Market bottom! Time to buy!” And those investors would be the very hope-filled buyers whose existence would indicate the market hadn’t hit bottom yet after all.

Okay, it’s not exactly Zeno’s Paradox, but it’s a flaw in the logic, yes? Not that it’s anything but an idle question, for me, at any rate. Market timing, I have always felt, is for people looking for ulcers.

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  1. Hey Scott- It’s a good point, one I’ve wondered about too. I think the problem for the market bottom seekers is that some are still probably thinking (er, hoping) only in terms of a relatively quick fix. We might be looking at the bottom now, or three weeks from now, but unfortunately it might be like the kind last seen from 1930-33. (The supposed “U-shaped” recovery predicted by folks like Nouriel Roubini.) Not fun to ponder, but it won’t require any further looking because we’ll be staring right at it, for a while. Hope not. Meantime, not all the bulls are dead yet:

  2. There is a distinction to be drawn in market sentiment. Any market has a large population of participants. To move a market, you need a majority of participants to be either bullish or bearish; when those number reach large enough proportions, it can be profitable to lean the other way. That is being a contrarian. Nowhere in this is it necessary for everyone to be a bull or a bear. Markets and market psychology is more complex than that.

    I also take exception to your comment about market timing. Capital markets like the stock, bond, money, and currency markets are marked by their liquidity. Liquidity is their advantage. You may sell a stock at any time, for instance, even if you’re not particularly crazy about the price you’re going to get. Other markets, like real estate, art, antiques, collectables, are not liquid. You may want to sell your first edition of “Moby Dick”, but without a buyer, you’re stuck.

    With this in mind, when investors buy stocks and hold onto them forever, they are giving up the biggest advantage they have, liquidity. Why would a rational person do that? When you study the stock market, there are clearly times when returns are ahead of or behind their average annual rates of return for long periods, decades in most cases. That is the time to sell.

    So why do most investors get stuck? I think there are two reasons. One, most investors are financially illiterate, and simply don’t know what to do. And they are too lazy to think for themselves.

    Second, the brokerage house model for revenues has shifted over the last quarter century from charging a fee each time you bought or sold to charging you a flat rate based on the amount of money you have in the market. Well, guess what? If your money is NOT in the market, but safely hiding out in a money market account, your broker’s income is doing to go down. Brokers don’t like it when their income goes down. So brokers offer advice to “stay the coarse”, “think long term”, and other such rot. Then the financially illiterate get caught in a big bear market with no place to go because they unwittingly forfeited their biggest advantage-liquidity.

    If you are going to war, it helps to know about your weapons. When the battle is raging, that’s not the time to pop open the instruction manual to figure out how this thing works.

  3. Ian Rae

    The market is a paradox. A sale only occurs when one person thinking it’s time to sell and another to think it’s the time to buy. You can’t sell to nobody :)

  4. Geo

    It’s like the theorem that there is no least interesting number. As soon as you identify it, it becomes mores interesting.

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