A Contrarian Indicator

Here's the theory behind the magazine cover indicator. By the time a something’s success or failure reaches the cover page of a major publication, it is so well known that it is fully known by everyone and those who want to capitalize financially have already done so. For example, once all the good news is out and a company makes the cover of business week, the stock is destined to underperform. The reverse holds for negative stories. It doesn’t have to just be about businesses, it can be about social themes too … remember the 2007-08 housing boom.

An academic study by three finance professors at the University of Richmond put the magazine cover story indicator to the test -- specifically as it focuses on coverage of individual companies. The professors culled headlines from stories in Business Week, Fortune, and Forbes for a 20-year period to examine whether positive cover stories are associated with superior future performance and negative stories are associated with inferior future performance. "Superior" and "inferior" were determined in comparison with an index or another company in the same industry and of the same size.

Here's what the professors found. The research supported the use of magazine cover stories as a contrarian indicator. The most negatively portrayed companies managed to beat the market by an average of 12.4%, whereas the outperformance of the media darlings fell to just 4.2%. The conclusion? Positive stories generally indicate that the stock's price performance has topped out. Negative stories often come right at the time of a turnaround.

The study confirms that it is better to bet against journalists than alongside them. It would be easy to jump to the self-congratulatory conclusion that journalists are incompetent. But that conclusion misses the point. Journalists aren't writing cover stories to make investors money. They are writing cover stories to sell magazines. And "hot topics" sell. But it also means that when a company or financial trend is featured on a magazine cover, the chances are that the trend is already widely known, and universally accepted.

With that in mind, this weeks Business Week cover should raise some eyebrows….

Just because the Government’s measured “version” of inflation, CPI, has been in stall speed for years, doesn’t meant it will always be. Additionally, and most importantly, not everything tracks the inflation rate. Health care is a great example as it has been rising almost 2x the annual “measured” inflation rate. For a what that means over time, take a look, and try not to laugh, at the hospital bill below for what it cost to have a baby in 1958. I think the total bill would be less than the cost than the charge of 2 ibuprofen in today’s medical reality (those that have had a recent surgery can attest to what I say)

The Bullish Case

Strongly trending markets don’t care about P/E ratios, inverted yield curves, the Presidents latest tweet or most everything else for that matter. Which is why it pays to watch price movement only and put everything else on "ignore". The semiconductor index, SMH, has always been my canary in the coal mine. It tends to lead stocks both up and down which is why it is a critical reticle into the US stock market and investors willingness towards risk. If its price is in an uptrend, risk is on and investors should be long stocks, very long. Of course, the opposite is also true. With that in mind let’s take a look at a price of SMH and see what it may be telling us.

After falling, like the rest of the market to its Dec 24th lows, price rallied impulsively higher, with only a few small, minor pullbacks before testing the prior high (resistance/overhead supply) made in June of last year (red horizontal line). After pulling back 4 days, price resumed its move higher eventually gapping above that prior level of resistance on high volume (~40% greater than average daily volume). The gap was the first sign and when confirmed with high volume let us know institutions (almost $1B traded on that breakout day) were buying. I don’t need to repeat it but higher probability profitable investments come in the direction of the current trend and when institutions are accumulating. Both of which the current chart of SMH is signaling. For those already in this ETF, the good news is you now have a very clear, simple and well-defined exit plan. If price in the short term cannot hold above the recent breakout, that would be an ominously bearish signal warning it’s time to take profits and watch from the sidelines.

Sure, the market is richly valued, sure it is overbought on virtually every level but the semis are telling us buyers are in control. Don’t fight the trend.

$8 Trillion

Global bond yielding less than zero (yes, that means lenders are paying the Government to let them hold their paper) now exceed 8 Trillion dollars. In total, there are 18 countries with negative bond yields ... in the 10th year of one of the largest global economic expansions no less.

Central banks only tool left in their toolbox in an attempt to counter slow or negative growth is to stimulate the economy by lowering interest rates. At some point all that want to borrow have done so and keeping rates so low harm only those who require bond income (retirees). With this going on since the 2008-09 crash and not having the desired effect one has to wonder why continue and then immediately brings to mind this quote

The definition of insanity is doing the same thing over and over again, but expecting different results – Albert Einstein

You need to look no further than the chart above to the reason why I am a firm believer Europe is winning the race …… to the bottom and the next economic crisis will begin from that region of the world.

My Favorite

Back about a month ago I wrote this blog post about the developing setup in bitcoin. At the time it had changed character from a steep downtrend to a long extended, rectangular base. This type of price movement reflects the waning of selling pressure and an equilibrium between buyers and sellers. All that is needed for this to be a tradeable investment opportunity is for buyers to begin to step in and take control. Control is borne out by higher prices and confirmed with volume during the break out to the upside out of the rectangle. That is exactly what eventually happened in bitcoin as you can see in the chart below

Rectangles are my favorite pattern because they are, in my experience, the most reliable and profitable patterns to invest from. Because they are so well defined, it makes the management easy and their upside targets very clear. In the case of bitcoin, its upside target was met and exceeded yesterday … a very nice 35% in 5 short days. Congrats to those that followed along and it is time to seriously consider locking in profits for some or all of your position if you have not already done so.

End of Cycle - On the Horizon?

Late in market cycles brings about peaks in animal spirits. Investors are confident and have long forgotten about the previous major market decline. Caution and discipline are an afterthought as they risk their investment capital in places they normally would not. This is normal human behavior. As an aside, investors do just the opposite right after that major market decline. None of this should be no surprise, it is how we are wired.

The chart below shows the number of companies that went public last year but don’t make money came in at 81%, a new, all-time high. Companies don’t have to make money, look at Amazon how many years they went before making a dime. But those companies are the exception, and like hen’s teeth, very rare. The other thing to note is that the last time it was this high was … wait for it … 1999-2000, the top of the dot com bubble. Remember those times when any company with just a business plan and no earnings went public?  Most of them eventually followed the fate of the dodo, never to be seen again. Remember those times? Oh, the naiveite of investors back then, right? It’s so easy when looking backwards.  

 While it’s not 1999 and things are different (they are always different), this time the top culprit was biotech companies. This is not a surprise considering their business model and upfront need for research and product development funding. Second place, were technology companies, another set in the “not a surprise” bucket. Interestingly 'all other companies' came in at a record high. 57% of “the rest” don’t make money. 

Add this to a number of signs that are popping up we are late in this business/market cycle. All cycles eventually end. Unfortunately, we won’t know it has ended until we can see it in the rear view mirror. When you add that this to the fact the current cycle will likely go on for longer than we all expect there is nothing to do for now other than not lose sight of the past.  Oh yah, and have plan

 Those who cannot remember the past are condemned to repeat it - George Santayana (1905)