Contrarian Indicators Are Signaling: Buy US Stocks

Thursday, December 17, 2009

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The list of contrarian indicators supporting the buying of US common stocks has become lengthy and weighty. Articles about stock risks and investor worries keep getting added to the pile. Like people postponing buying a new car, the potential demand continues to grow. All it takes is a spark to set it off. In the case of stocks, it is not going to be a government incentive – rather it likely will be an “unexpected” stock market rise that spurs investors to buy.

Here is the picture today…

In my recent write-ups, I have focused on common stocks being desirable because of economic improvement and the expected earnings growth. Today, I want to focus on the contrarian indicators. As I described last week, reading such indicators correctly can produce outsized gains. I believe we are at such a place.

Supply and Demand

Corporate issuance of common stock has been limited. IPOs (initial public offerings) and other sales have remained below normal, except for financial companies that need to rebuild their capital.

Most of the corporate financing taking place is in the bond market, where companies are happily gobbling up cheap funds from enthusiastic buyers.

However, there has been a steady supply from an unexpected source: investors (both individuals and institutions). Instead of buying to rebuild shrunken allocations to US stocks, they have been selling. At institutions, they are intentionally lowering their allocations. Individuals, although steadily buying mutual funds, have focused primarily on bonds with some interest in foreign stocks. But they have continually sold US stock funds.

Even the foreign government SWFs (sovereign wealth funds), considered the potential saviors last year, are saying “no” to more stock purchases. The reason, according to Reuters, is “… even if valuations are attractive, sovereign funds, just as other cautious investors, will wait until they can be pretty confident about a recovery before buying risky assets” (Reuters, “Soured investments to keep sovereign funds wary in 2010,” December 17, online). In investing, waiting until the news is in means paying full price.

Psychology

The current stock market psychology is different from the two bear market bottoms we recently experienced. Last October, there were strong pessimistic feelings accompanying the panic sell-off. This March, there was continuing strong pessimism, but a kind of numbness had set in, causing a non-buying drop. In today’s market, the strong pessimism is gone, but there is little optimism, resulting in the continuing runoff discussed above.

In spite of the underlying good economic and company news, the media, in its typical role of simply mirroring investor psychology, is playing up the risks of owning US stocks. Here is a prime example:

The Wall Street Journal (December 7, page C-1): “Bull Market Exhibits Some Signs of Aging” – This is one of the most misleading articles I have read recently. If the economy is still recovering – it is – and is likely to return to a sound growth rate – it is – and companies have strong finances – they do – and earnings forecasts are strong – they are -, then the market is still young – particularly with all investor groups holding less US stocks than normal.

So, why don’t we read more positive media reports if prospects are so good? Because most reporters are not investment professionals, so they are either unaware or unsure of contrarian investing. Also, they worry about losing readership by being viewed as out of step. Why not just wait until the tide turns, then write about the new trend when everyone can see it and is interested? That may help a reporter’s career, but it produces lousy performance for investors.

Contrarian investor conclusion

Now is the time to own US stocks. The saying is that the spoils go to those who stay calm and think clearly when others panic. While we are past the panic environment, we are still in a time of US stock concern and high risk sensitivity. Investor worry and net selling while underweighted means common stocks are priced lower than normal. This situation gives us the opportunity to accomplish the first part of the recipe for superior performance: “buy low, sell high.”

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