This Wall Street bearish contrarian is a bad idea
On Wall Street, genuine contrarians are rare. When blood is running in the streets, to quote the famous and genuine contrarian Nathan Rothschild, hardly anyone wants to buy.
This is worth remembering because everyone on Wall Street has become a latter-day contrarian, who claims to detect the widespread bearishness that justifies a contrarian buy signal. By definition, not everyone can be a contrarian. When a genuine contrarian buy signal is triggered, few will believe it or follow it.
One of the best descriptions of a true contrarian comes from British economist and philosopher John Maynard Keynes: For it is in the essence of his behaviour that he should be eccentric, unconventional and rash in the eyes of average opinion. If he is successful, that will only confirm the general belief in his rashness, and if he is unsuccessful in the short run, he will not receive much mercy. Worldly wisdom tells us that it is better to fail conventionally than to succeed unconventionally. The core insight of contrarian analysis is that extreme positions are far more often than not exaggerated — and to that extent wrong. When the news is good and bullish, it is a good bet that investors are ignorant of the bad news that also exists. The path of least resistance is down, and stock prices have been bid up to unjustifiable levels. The same process works when bearish sentiment is at an extreme.
Read: Those who buy stocks the day the S&P 500 enters a bear market have made an average of 22.7% in the last 12 months.
Wall Street bear who called the stock market selloff sees the S&P 500 up another 7% before going lower.
In the wrong hands, this core insight becomes the excuse for sloppy thinking. If you want to be bullish and claim that contrarian analysis supports your position, you can always find plenty of bears to be your contrarian foil. At the same time, you can be bearish and still wrap yourself in the contrarian flag, since there will always be some bulls you can oppose.
The antidote is to rely on an objective measure of sentiment. Only when it reaches an extreme, your contrarian analysis kicks in. There are many different objective sentiment measures, and it is beyond the scope of this column to analyze their relative merits. The key point I am making here is to pick one and then follow it.
I have no hunch that you will not find contrarian support for the belief that the bear market is over. As I reported last week, several objective sentiment measures indicate that we have not seen the towel capitulation that usuallyaccompanies major market bottoms.
The path the market takes to a new all-time high will take it lower first, according to my contrarian analysis of the sentiment indicators.
Mark Hulbert is a regular contributor to MarketWatch. He can be reached at mark hulbertratings.com
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