Saturday, September 03, 2011

Undeniable Truths of Money #3: The Herd Is Always Wrong At Inflection Points

Q:  What significance does October 10, 2007 have to investing?

A - It was the all-time high in the stock market
B - It was the most bullish day in the history of the stock market
C - It was the best day to sell in the history of the stock market
D - It was the worst day to buy in the history of the stock market
E - All of the above.

For those who still believe the stock market is a discounting mechanism and a predictor of the economy 9 months in advance, you need to dig the gravel out of your cranium.  The summer of 2008 was a train wreck in the US economy, but if you went by the stock market "forward looking mechanism," there should have been money raining down from Heaven. 

Why?  What happened?

The greatest fool (peak idiot) in US stocks was found.  He is the one that bought on 10/10/07, and he wasn't alone.  The pack was more invested on that day than at any other time in our history.  Bulls were running hard and it looked like nobody would ever stop them.  They had climbed that wall of fear coming out of the blowup in the Bear Stearns hedge funds to their high water mark, and it was all downhill after that.

In reality, the minority (contrarians) were correct on that day.  The bears were the real winners on 10/10/07.

How can this be?  CNBC tells us that bullish sentiment is a good indicator of future performance, but is it?  We say no.

10/10/07 was an inflection point.  We only know that in hindsight, because nobody rings the bell at the top.  All the buyers were in.  If you weren't in by that point in time, you didn't want to be in.  All the buyers were in and the only thing left to do was sell.  They had to sell into a growing crowd of sellers.

This also works at bottoms.  03/09/09 was a bottom.  Fear was never higher than that day when the S&P hit 666, when all the sellers had punched out.  The only thing left to do was buy.

The trend my be your friend, but not for long.  The trend only works between inflection points, and the longer it takes you to recognize the trend, the shorter the friendship will be.  If the trend is very popular, it has almost run its course and Mr. Market will do what he does best and screw the most people out of as much money as he can.  The contrarians are the ones that clean up, but even contrarians need to exercise caution.  It isn't enough to simply be "contrarian."  All that does is make you insufferable at parties (ask me how I know this).  Contrarians need to keep quiet during the periods where trends rule, which are typically midway between inflection points.  They need to watch for trends losing steam on the way up, or diving into a panic on the way down, as those are the indicators that too many people are on the same side (which will ultimately be the wrong side) of the trade.

When the boat gets overloaded, it doesn't take much to tip it over.

Bainbridgeislanddreamhomes peaked in October of 2008.  California equity money dried up about a year earlier.  The peak money was in and now the escalator stopped.  The pressure to move the market upward died, so the only thing left to do was sell into a declining pool of buyers.  The worst time to buy a Bainbridgeislanddreamhome  was when the market was at its most enthusiastic.  The sellers were the ones with fortune and glory on their side.

That's why this is not the best time to buy a home.  The best time to buy will be when all of today's conventional wisdom is shattered.  Interest rates will have to be peaking, not troughing.  Unemployment will have to be peaking.  Rather than hearing "BUY NOW OR BE PRICED OUT FOREVER," you will be hearing "WHY WOULD YOU EVER BUY A BAINBRIDGEISLANDDREAMHOME, SINCE THE VALUE ALWAYS GOES DOWN?"  Down payments will be high, not low.  Nobody will think of housing as an investment - it will simply be an expensive, money pit that is a necessary evil of life.

The herd and conventional wisdom will be wrong then, as well.

8 comments:

Anonymous said...

Bravo again.

What I don't understand is how the county assessor can get away with these ridiculous valuations. My latest assessment is nearly $75K higher than the appraisal I got in October 2010, and $50K higher than a much nicer house just sold on my street (another house, also nicer, sold for $100K less).

If some fool offered me the assessor's price for my house, I'd happily take the money and run. I own 50 acres free and clear in an area with no property tax. Not only would I pay off the mortgage here, but have enough to build on my 50 acres and have a nice chunk of change left over.

Eleua said...

Assessors are rarely going to reflect the actual value. First off, they are assessing in arrears, meaning they are behind in valuations. You are being assessed on values 18-24mos in the past.

They under-assess on the way up and over-assess on the way down. I always knew that we would get many upset people during these times, as property values drop faster than assessments.

The second problem comes from the fact that they have to guess at the value. There is no "bid/ask" on 123 Park Ave. The assessor has to model what the price might be, just as your average NAR-bot does. The NAR-bot has better info than the assessor, so valuations are all over the board.

If you are a regular reader of the Westsound's primier economic blog, you know that the IER advocates reducing to cash and sittin gout the impending disaster. If you have 50ac free-and-clear, and you can sell here, build, and have money left over, you are at a very fortunate position in life.

Best wishes.
Stay solvent.

Jillayne Schlicke said...

Eleua,

You were right....How many years ago was it that you said people were going to be protesting in the streets and that day is now here. I think the protests will grow. When BOA fails, if the government rescues them, people will be out protesting in front of their local BOA branch. I'm shining the batman spotlight on the sky looking for you and your crystal ball...what do you see happening next?

Miss you,

Jillayne

Anonymous said...

Yes, they really need you at Seattle Bubble. Scotsman is buying a house.

Anonymous said...

"The best time to buy will be when all of today's conventional wisdom is shattered. Interest rates will have to be peaking, not troughing. Unemployment will have to be peaking. Rather than hearing "BUY NOW OR BE PRICED OUT FOREVER," you will be hearing "WHY WOULD YOU EVER BUY A BAINBRIDGEISLANDDREAMHOME, SINCE THE VALUE ALWAYS GOES DOWN?" Down payments will be high, not low. Nobody will think of housing as an investment - it will simply be an expensive, money pit that is a necessary evil of life."

So the best time to buy was 2011?

Anonymous said...

It's been over 6 months of silence. I hope you didn't kill yourself.

Anonymous said...

Hey, did I see you posting off of an ancient thread at the Seattle Bubble the other day? Hooray, you're not dead. You should post more often. There is a certain lacking of style in many of the posts these days.

QUALITY STOCKS UNDER FIVE DOLLARS said...

The herd is always wrong when it comes to investing. It was wrong in 1929. It was wrong in the year 2000. It was wrong in 2007. It was totally wrong about financial services stocks in 2007. It was wrong about gold in the year 2000. It was wrong about commodities stocks in the year 2000. And it was wrong about oil stocks in the year 2000. Trees really do grow to the sky. That is until theirs a thunder storm.