Dave Gilreath, CFP

Did you ever wait until closing time to visit a bakery with hopes of getting still-fresh goods a discount—or at least a few free cookies thrown in?

This is kind of like the time-honored practice of contrarian investing, where investors seek to benefit by stepping to a different drummer than the herd. Just as most shoppers’ habit of going to the bakery on a Saturday morning might create value opportunities later in the day for the patient, the investing herd creates opportunities for contrarians.

These investors think in terms of WWTHD (What Would the Herd Do?), look at what the herd is actually doing, and then often do the opposite.

To identify value stocks, you look for companies that, because of disfavor, have share prices that don’t reflect factors that might normally suggest higher values: their historical performance and/or current fundamental characteristics.

That’s the “what” of value investing. The “when” can be a lot trickier. How long you end up waiting for a value stock to rise—how long its price ends up languishing&mdash;is a critical factor in contrarian investing success. Yet the herd sometimes makes this easier by giving off signals that are historically fairly reliable. Recently, the herd has been making such noises, known as contrarian buy signals, indicating that it may be a good time for contrarians to invest.

Low numbers on the investor sentiment survey of the American Association of Individual Investors (AAII). The membership of this organization has the dubious distinction of inadvertently identifying good times to invest precisely because of their belief that it’s a bad time. AAII members’ bullishness/bearishness tends to reflect broad investor individual sentiment—herd sentiment. Recent AAII surveys brought the highest number of bear responses in the last seven years. Respondents’ degree of bullishness/bearishness is reflected by their answers to survey questions on how they expect the market to perform over the ensuing six months.

In mid-May, the AAII bullish rating was 23.7%, the lowest level of 2020, landing between one and two standard deviations from the mean--quite a low point historically. Bullishness has been greater than one standard deviation from the mean 265 times since 1987, and the average 12-month forward return from the S&P 500 during that period was 17%.

This greater-than-average return suggests that the association membership usually gets it wrong—that they may be expressing fear that leads to selling, pushing down share prices (particularly those of out-of-favor, non-herd stocks), and thus setting them up equities for gains over the next 12 months. Thus, the skittish herd often enables the opportunistic contrarians.

Recent numbers from Morningstar on overvalued/undervalued stocks. The company’s overvalued/undervalued indicator generally characterized large-cap stocks as being 

 in May, based on its estimations of their 

In May, extreme spikes in the equal-weighted S&P 500 Index, compared with the capitalization-weighted performance in that index. The cap-weighted index is what everyone talks about. It’s dominated by the largest companies in the index, which proportionately have a greater weighting in index performance based on capitalization. The equally weighted stocks in the index got killed in March; the damage was much less for the cap-weighted members of the index.

The fact that these equally weight companies were still down about 15 percent in early May (while the cap-weighted had bobbed up to about 9 percent off their highs) might indicate an inflection point. When that has happened over the past three decades, out-of-favor value stocks tended to begin shining, bringing gains to investors with the acumen (or professional active management) needed to pick them, as opposed to indexing.

A through-the-roof spike (to levels above the 99

 percentile) in the St. Louis Federal Reserve Bank’s Policy Uncertainty Index in late April. This spike was higher than any over at least the past 35 years. Spikes in this index, which measure public levels of uncertainty regarding economic policy, have long been a strong contrarian buy signal, as they’ve preceded periods of substantial growth in the S&P 500. The herd doesn’t like uncertainty, which suppresses their tendency to invest. This lowers prices, creating room for growth.

Assuming these buy signals rhyme today as they have in the past, this may bode well over the next year or so for sectors currently beaten up by impacts of the coronavirus—but poised to come back when the real economy resumes. The most extreme such contrarian play is energy, which is particularly poised to surge when the global economy chugs back to life, using more and more oil. (There are tankers full of oil lingering offshore, waiting to unload as supplies on already land are used up, for want of real storage in a system designed for continuous high consumption and flow.)

Interestingly, since the market lows hit on March 23, the energy sector has registered the best performance of all eleven S&P 500 sectors.

Also in the beaten-up-value-department are credit companies that own their own debt, such as Capital One and Discover, and regional banks, which are most hurt among lenders by low borrowing demand and the current rock-bottom rates that narrow spreads and crimp profitability.

While contrarian buy signals are no panacea (there’s no such thing in investing) for projecting the overall market or anticipating comebacks of specific companies, they can be a helpful tool for investors seeking to make informed decisions. Any one signal isn’t as significant as a convergence, such as what we have now. The more valid signals you can discern, the better idea you’ll have of what the herd is thinking and how you might benefit from it.

David Sheaff Gilreath, a certified financial planner, is a 39-year veteran of the financial service industry. He established 

, a portfolio management company based in Indianapolis, with partner Ron Brock in 2001. 

The firm managed over $1 billion in assets nationwide as of 12/31/2019. 

Articles

The Investing Herd Data Indicates Potential Opportunity Ahead

Google, Facebook, and Amazon have an ingrained image as growth stocks that deliver great long-term performance but tend to be pricey.  

Yet these behemoths and some other big tech names now have lower prices, enabling them to make a rare appearance on the other side of the growth/value dichotomy and to pass through risk-oriented screens that are normally biased against them.

These screens, which favor stocks with relatively few negatives regarding valuation, performance and investor sentiment, tend to reveal companies that will likely have higher returns because of lower risk in these areas. As these screens have an inherent bias toward 

, they tend to discriminate against big tech, but now that prices are down, some big tech names are passing through. These companies are still posting good revenue and earnings, making them particularly attractive now.

Some tech names--like Apple, Intel and Cisco Systems--might normally be expected to shift into the value category. However, some more volatile tech stocks are now making this cut. These include Texas Instruments, PayPal, Broadcom, and Google. In the communications service’s subsector, Sirius XM and Yelp join Facebook on the other side of the screens. And in the consumer discretionary category, Booking Holdings joins Amazon as being lower risk. This is remarkable, considering that in the last four or five years, you’d be hard-pressed to identify a period when such companies made it through lower-downside-risk screens.

 status are exogenous factors affecting market perception, pushing down prices while surface revenues and earnings have continued to grow. This combination of characteristics has given these stocks value characteristics for the first time in years, or perhaps, ever.

, Facebook shares were trading at $38 (17%) off their  52-week high, hit in mid-summer; Amazon shares, $299 (14%) off their 52-week high, hit around the same time; and shares of Google’s parent company, Google (Alphabet), $47 (4%) off the near high in mid-summer. This hasn’t been a downtrend, but a stall of their perennial yet halting upward climb, albeit with occasional dips.

What’s depressing the prices of these and other tech companies that have long been squarely in the growth category? Likely factors include:

Widespread recession. The flattening and inversion of the 

 in the last year has led to an irrational fear of recession. Though recent inversion and general flattening haven’t resulted in recession, the pessimistically faithful hang on to that belief like grim death—despite the assessments of many prominent economists and analysts that recession probably isn’t in the cards for 2019 or probably even for 2020. And never mind that many of those on recession watch in 2018 were focusing on the 

key factors that preceded the last six recessions (i.e., rising oil prices and the Fed’s raising interest rates to fight inflation)

 aren’t present, or that moving rates no longer have a big impact on the likelihood of recession. To the extent that some yield curves might be considered predictive, this, too, is now a false indicator because of fundamental changes in the way the Fed manages monetary policy, which started in 2008, explains  First Trust Portfolios economist 

. As far as retail investing is concerned, talking heads who confuse recessions with bear markets add to fear and market volatility. Adding to the general financial necromania is the widespread assumption that, corrections aside, the unusual length of this bull market is somehow indicative of a near-term crash. But there’s no objective basis for this thinking.

Market fears of the performance impact of government regulation on both sides of the pond. The European Union has taken antitrust actions against Google and slapped Facebook with privacy-protection strictures, while in the U.S., congressmen from both political parties’ grumble about regulating these two companies, and potentially Amazon as well. Congressionally mandated divestiture poses risks for Facebook, with its ownership of Instagram and WhatsApp, and Google, whose companies include YouTube, Android, and DoubleClick. If this happens, it would be years off, as the companies can easily spend billions on lawyers to fight it so they can keep operating as they currently do. And even if Congress manages to make a case that Google’s search-engine-for hire is a monopoly (actually, other sites are free to compete with it), how could/would they possibly break it up? After all, it’s one, huge entity. Nevertheless, these headlines doubtless have affected prices.

Concerns over the trade war with China, which shows no signs of abating. High volatility from alternating signals of resolution and intransigence from inscrutable leaders on both sides of the Pacific have hammered indexes and with them, Facebook, Google, and Amazon.

Though Amazon shares have languished for the last fifteen months, the stock has been characterized over more than a decade by periodic steep upward spurts to new highs. Languish, spurt, languish has often been the pattern. The performance of Google and Facebook has followed a similar pattern. With this history, it’s only logical to consider whether the new value status could be setting up another spurt.  

This seems fairly likely for Facebook and Google, whose coffers are destined to swell over the 14 months from election advertising. And during this period, the national addiction to Amazon’s one-click ordering and two-day Prime delivery isn’t likely to abate.    

Whether the growth-to-value trend will broaden, and how long it will continue, is unclear. But its continuation might presage a redefinition of the value category. Regardless, these three giants’ robust sales and earnings can now be had for lower prices that seem itching to rise.

Sometimes, the sure-fire investment isn't the safe bet upon closer inspection.

Tech Wolves in Sheep's Clothing Still Have Teeth

While there’s a lot of noise about market failure and recession, when the total picture is assessed more dispassionately, the inescapable conclusion is that there’s no cause for alarm.

One of the main drivers of economic fears is a change in the ratio of long-term and short-term bond interest rates known as 

. These inversions are widely believed to necessarily precede recession, but it’s much more complicated than that. The last six times a yield curve inversion was followed by a recession in the ensuing months, the Fed was raising rates to fight inflation and oil prices were spiking. Neither is happening currently.

Going by the Delphic predictive power of rate curve inversions, this year should have started with recession (in which we might still be mired), based on an earlier inversion in mid-2018. Yet, according to the Fed at the time, alarmists were actually looking at 

, and the Fed explained last summer that the right curve didn’t indicate near-term recession. So far, the Fed has been proven correct.

Amid the hysteria over the current inversion, various financial luminaries—including leading CEOs, members of the Federal Reserve board of governors and economists and analysts at large financial institutions&mdash;are discounting the likelihood of a recession this year or even next. All cite strong consumer spending, including strong retail sales in July and surveys showing extremely high consumer confidence&mdash;so high that the negative  outlooks of talking heads aren’t likely to deter consumers from their compulsion to spend it when they’ve got it, amid current high employment.

Moreover, many aren’t paying attention to the connection between the last recession and the bull’s duration. The last recession was indeed dire—deemed more like a depression by some economists&mdash;and though the economic growth to climb out of it has been fairly steady, this growth has hardly been a sprint. Though consumers are spending again, this spending is nothing like what they did in 2006-07, as the nation approached the Great Recession, or in the late 1990s, as we approached the tech crash of 2000. Many people were severely burned in 2008-2010, and some have never been the same financially or psychologically. As a result, they’re now more conservative in their spending, even in these relatively good times.

All this contributes to the length of the current cycle of economic growth. We don’t have the 3.5% growth that economists used to refer to as trend growth, but we do have around 2%, with projections for this rate to continue. It’s not gangbusters but it’s getting the job done.

It comes down to this: The reason this upward economic phase has run so long is that the economy had so far to come back, and it has come back so gradually.

Some persist in assigning a shelf life to this bull market, and this one is no different. Just as they see recession coming despite high employment and consumer spending, they see a bear market ahead despite better-than-expected Q2 corporate earnings. Doomsayers link a global slowdown (highlighted by the onset of recession in Germany) as a force that will drag down the U.S. market, when really, much of the effect is just the opposite. Foreign money has no better place to go than Wall Street, so it keeps flowing to American shores.

As for the length of the current bull, the market hasn’t historically run on a schedule, allotting a set period to bull or bear territory. And although the market and the economy aren’t the same thing, greatly generalized outlooks for both are being affected by fears stemming from some of the same causes. Chief among these is Trump’s  tariff war with China.

The negative economic impacts of the trade war are vastly over-stated, primarily because many people over-estimate the importance of trade to the U.S. relative to its massive global gross domestic product. The U.S. exports and imports relatively little, it produces most of its stuff—especially now that domestic oil production has risen in recent years.

Of course, the tariff war isn’t helping American multinational companies: those engaged in significant amounts of international trade. It makes expansion and plant siting more difficult, and hence more tentative, as it’s impossible to predict fiscal outcomes of such moves when companies don’t know what all the rules and costs will be.

However, the potential impact of the tariff war on corporate earnings has been greatly exaggerated, resulting in new fears that have increased volatility in an already gyrating market. Indeed, though talking heads and the financial press seem certain about what made the market go up or down sharply on a given day, they really don’t know. Often, the cause is individual fear, turbocharged by institutional trading algorithms. Sure, trade war fears have affected the market, but volatility had increased significantly before the first tariff salvo was fired.

This is the case even though the tariff war doesn’t seem to have damaged multinationals much, if at all. As of late July, performance of the 50 S&P 500 stocks with the highest volumes of foreign sales this year was up about 25% over 2018, compared with only a 10% gain by companies with no foreign sales. So big-trade companies that did poorly last year have come back this year, more than non-foreign-trade companies, even with the supposed albatross of tariffs.

This tells us that the trade war fears are mostly just fears—and that the market generally expects the trade war to end. Of course, even though the only thing we currently have to fear in this regard is fear itself (which resulted in some wild gyrations in August), more sanguine expectations may moderate as the war drags on. This protraction seemed more likely as of late August, in the context of tariff breast-beating by Trump and Chinese President Xi, and comments made around the G7 summit. Such events increase volatility, which could be viewed as buying opportunities for the less afraid.

If you fear the trade war will drag on longer than your investment time horizon—or you just don’t believe multinationals won’t sustain real damage&mdash;a secure strategy is to just invest in low-trade domestic companies.  If you’re more bullish and believe that the war is depressing multinational companies’ value below what it otherwise would be, investing in them now might prove profitable when the war is finally over.

heaff Gilreath, CFP® a 38-year veteran of the financial service industry, established 

, a portfolio management company based in Indianapolis, with partner Ron Brock in 2001. The firm has more than $1 billion under management.

Recession fears are growing, but upon further inspection, they might not be so bad.

Why Market and Recession Fears Are Greatly Exaggerated

Sometimes, what most people think is good for markets isn’t, and what they think is bad for them is actually good.

A domestic example lies in the recent figures on consumer sentiment, showing 

. This is the kind of statistic that tends to prompt market optimism. This is curious because upward domestic markets historically haven’t always followed upward consumer sentiment.

Financial media sometimes gets investors all worked up about the presumed benefits of consumer optimism to the stock market. Yet, contrary to popular belief, higher consumer sentiment is, by some measures, linked 

. Low consumer confidence has historically preceded higher stock market returns, making it a contrarian indicator.  

However, anyone predicting a strong domestic stock market over the next year or two will probably end up being right--for reasons having nothing to do with consumer sentiment.

This potential opportunity is largely because of a global scenario that may seem negative for US markets in the short run but might actually help them long term. People are worried about the impact of the tariff war with China on the U.S. economy (and hence the markets) but in the scheme of things, this disruption’s impact on China can actually benefit American stocks. As well as, the current political instability in Europe. This global tumult will mean that foreign money will continue to pour into US markets because it doesn’t have a better place to go.

A closer look at underlying causes of the tariff war with China—which has underlying issues that generally have bipartisan consensus, so the election won’t completely change the US position&mdash;reveals it’s really not so much about trade as it’s about national security. At its core is Huawei, the Chinese mobile phone manufacturer that, American intelligence agencies suspects, engineers phones to 

. Following this determination was a federal ban on importing these phones, throwing a monkey-wrench into Huawei’s plans for market dominance in the coming 5G wireless era. By enacting this ban, the U.S. is indirectly disrupting a key part of China’s global trade plans as they involve 5G and Huawei in a big way.

 and tariffs have become the US government’s counter-weapon in this trans-Pacific tit-for-tat match. Generally, trade with China has a much smaller impact on our economy than most investors think. The impact of the day-to-day volleys in the tariff war on US markets would be less impactful if more people were aware how little we sell to China: annually, about $200 billion worth—less than one percent of our total economy. Yet some keen observers believe that China wants the trade war because it could provide a 

convenient opportunity to devalue its currency

, a move that would ease the pressure of the nation’s massive debt overhang.

China’s massive debt could eventually bring a deep recession to the world’s second-largest economy. This aside, there are other reasons to doubt its long-term prosperity. Decades of meteoric growth have brought a higher standard of living and increased wages, resulting in higher costs for manufacturing goods for Americans. These higher costs are already sending this manufacturing to poorer places, such as India, now the world’s fifth largest economy, with a population that is nearly as great as China’s.

India is the world’s largest democracy--a positive growth factor, in contrast with China, whose Communism surveillance and oppression of individuals and limitations on personal freedom (get a jaywalking ticket there, and you literally lose freedom points) is viewed by some experts as likely to increasingly stifle worker spirit; capitalism flourishes best in democracies. In addition, China has increasing global trust issues stemming from systematic and government-sanctions copyright violations. All these factors point to a tapering of the global dominance of the world’s second-largest economy and decreasingly attractive markets there.

Europe also has its troubles. The pro-populist outcomes of recent elections have weakened pro-European Union parties, creating doubt about the union’s stability and the health of European markets. The United Kingdom is in disarray over Brexit and no matter how they exit the European Union, the likely impact on its economy will be profoundly negative. Further, with the exit of Chancellor Angela Merkel, the future of Germany’s economy comes into question, and France is also rife with social divisions. So, there are serious troubles affecting economies and markets in the 

world’s seventh, fourth and sixth largest economies

Meanwhile, bond rates have been declining in 

 (the third largest economy) and actually inverting in 

Europe (where bond investors actually pay companies to lend them money

), making the rates of bonds from domestic issuers attractive and the US stock market even more favorable by comparison. Foreign investment money keeps coming here, so US markets keep chugging along.

There are those who worry about the end of a record business cycle—as though there were any significant data pointing to this (there isn’t) or there was some kind of time limit on expansion (there isn’t). But the factors we 

 know about all point to market growth. Not that this upward ride will be steady. The market will likely remain choppy throughout the summer, which can create buying opportunities for the faithful.

The reigning perception is that many of these dips are being caused by trade tensions and indeed, the two coincide. But the real reason for the dips is that uncertainty amid a tariff war is suppressing corporate growth—temporarily. Companies can’t make expansion plans when they don’t know what the trade rules will be. So, they’re hoarding their expansion cash. When the trade tensions ease, this pent-up expansion demand will likely let loose, driving the market even more.  

But even without this, 2019 estimates forecasts call for good earnings, and stock values tend to march in lockstep with earnings. This growth should continue, however haltingly, for the next year or two. Along the way, I believe the Dow Jones Industrial Average could reach 30,000 sometime in 2020.

For more personal finance tips and insights, read on 

heaff Gilreath, CFP® a 36-year veteran of the financial service industry, established 

Tumultuous times globally can lead to disarray and panic when it comes to market outlook, but sometimes the hype doesn't match up with the facts. What might look like something bad can actually turn out positive.

Author | Dave Gilreath, CFP

Articles

The Investing Herd Data Indicates Potential Opportunity Ahead

Tech Wolves in Sheep's Clothing Still Have Teeth

Why Market and Recession Fears Are Greatly Exaggerated

How Global Tumult Can Help US Markets