Interview With GoBankingRates.Com – Part 3

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We are posting an additional portion of an ongoing interview I have had recently with another blog site,  Here is a transcription of the third part of that interview.  You can read the first two parts in our postings on October 1 and October 8, 2010.

6.  You discussed in your recent post, “Beware of Unanimous Opinion,” that investors seem to be most optimistic right before a market downturn, and most pessimistic right before a rally.  Why do you think this happens?

Most men and women are uncomfortable out of the mainstream, especially in areas which we do not understand well.  We are far more comfortable in concert with the herd.  History demonstrates clearly that the longer a stock market trend lasts–in either direction–the more adherents it gains.  On the up side, making money reinforces our earlier “correct” decision.  Success breeds confidence.  Seeing others make money builds that confidence to the point at which not joining the party seems foolhardy.  Very few people recognize that reversion to the mean typifies investment markets.  Instead their behavior argues the belief that trees can grow to the sky.

From many decades of personal experience, I can attest to the difficulty of convincing people that it is prudent to buy stocks after long declines.  From 1974 to 1982 I gave numerous talks around the country with minimal success at convincing people of the wisdom of buying stocks, despite the fact that stocks then had some of the most attractive valuations in a generation.  Conversely, it was virtually impossible to persuade investors to lighten their equity portfolios in the late-1990s, despite the most extreme overvaluations in history. 

7.  If you were to take a contrarian approach, as in going against the majority sentiment, you would be buying low and selling high in the extreme scenarios from the previous question.  Why should you take the contrarian approach all the time?  Are there risks by constantly going against the grain?

There certainly are dangers in going against the majority of investors.  The majority is right in its judgment most of the time.  That buying or selling pressure from the preponderance of investors is what pushes market prices up or down.  Sentiment measures become helpful contrary market tools only when sentiment reaches extremes of optimism or pessimism.  There is a logic to why that is so.  When a market trend continues long enough that almost all investors become convinced of its permanence, most investors have already acted on their belief.  There is little remaining potential to push the trend farther.

While sentiment indicators can be very helpful tools in identifying tops and bottoms, they are not foolproof.  Markets can remain overbought or oversold for a long time.  A great insight attributed to economist John Maynard Keynes is that markets can remain irrational longer than you can stay solvent.  With that in mind, the prudent investor will learn what the historical sentiment extremes are for various asset classes, but will get confirmation of those studies from other fundamental and technical measures.

8.  What is the Daily Sentiment Index and how do you use it to gauge whether investor optimism or pessimism is off balance?

The Daily Sentiment Index is one of many measures of bullishness that I review regularly from such data collection services as Ned Davis Research, Elliott Wave International and Decision Point.  This kind of study is done for virtually all asset types.  Such surveys measure how large a segment of a universe of investors–individual or institutional–is bullish or bearish.  By evaluating the performance of the studied asset when bullishness is at various levels, a performance grid can measure how well the asset has performed when investors are highly bullish or highly bearish.

In the Daily Sentiment Index study for the S&P 500 as reported by Ned Davis Research, for example, the S&P 500 has declined at an average 14% per-year rate when more than 79% of respondents are bullish.  Conversely, the index has gained an average 20.6% annually when 24% or fewer are bullish.

As the name implies, the Daily Sentiment Index is a measure of short-term sentiment.  There are similar studies that review sentiment over a range of time frames in different ways.  Among other studies I review regularly are stock mutual funds’ cash/assets ratio, the National Association of Active Investment Managers average equity allocations, the percentage of various assets above moving averages of varying lengths, the VIX measurement and an assortment of put/call studies.

None of these offers a definitive, always- accurate forecast.  All they can do is provide warnings that too many people are on one side of a trade and that at least a correction is probable.

9.  We know that investors usually fly to gold during times of economic uncertainty, but why is the stock market experiencing so much optimism as well?

There is no close correlation over time between the prices of stocks and gold, although both have been very strong in 2009 and 2010.  The two asset classes typically respond to different stimuli.  I suspect that their common success over the past two years is a function of investors becoming increasingly emboldened to accept risk, then putting money into assets showing strong momentum.

We are an optimistic people generally, and that optimism grows the longer a trend remains in place.  With only relatively brief interruptions, stocks performed exceptionally well from 1982 into 2000.  Bullish enthusiasm built up quite a head of steam moving into the new century.  The recession and stock market collapse in the early years of this century dampened that enthusiasm, but it bounced back quickly when stocks started up in 2003.  When stocks collapsed again from 2007 to 2009, a deeper level of damage may have been done to the psyche of the individual investor.  Stock prices have risen again very strongly from the bottom in 2009, but the buying power has come mainly from the professional investment community.  The individual investor has been far slower to get back on board the rally.  This dynamic is leading a number of investment analysts to forecast a longer bull market because the individual is expected to participate in great numbers before this rally ends.  Of course this is possible, but there is precedent calling that expectation into question.  In the last extended stock market weak cycle from the late-1960s to 1982, it took two major stock market declines to diminish the individual investor’s strong desire for common stock ownership.  Enthusiasm revived fairly strongly after the serious 1969-70 decline, but it took the crushing 1973-74 bear market to finally kill investor bullishness.  It then took a decade and a half of rising stock prices to rekindle strong bullishness.  Having now endured two crushing stock market declines over the past eleven years, the individual investor may be slow getting back into stocks. The Fed’s expressed intention is to “force” investors back into higher-risk assets like stocks by driving risk-free interest rates essentially to zero. The jury is still out on whether or not the policy will succeed over the longer term.


Tom Feeney is the chief investment officer for Marathon Asset Management Co, a registered investment advisor with the Securities and Exchange Commission, and for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more by either of the firms, you are invited to email your interest to or call (520) 529-2900 to speak with one of the Portfolio Coordinators.