By Charles Tumlin
Some of the most effective market tools that we have used over the years to explain the importance of having an investment game plan are magazine covers. We often find that magazine covers typically present the most concise summary of investor psychology available.
The average investor, as is perhaps best illustrated in various studies from Dalbar and others, over-corrects to changes in the market as they shift their 401(k) based generally on the feeling
in their gut. Simply put, investors who are left to their own devices will, in sum, make emotional, irrational decisions and underperform over time as a result. They will buy when it is comfortable and sell when it is uncomfortable and that makes providing for a more comfortable lifestyle down the road a much longer road indeed.
Magazine covers typically help reinforce this modus operandi by providing a picture of the market’s collective conscious. For instance, the psychological effects of buying the “top” of the market is a tough one to overcome especially when media headlines are so bullish. At the end of the day, the fear of buying the top of the market ultimately comes from the lack of sell discipline. It is for this reason that we find mainstream magazine covers so useful, they simply provide a reflection of what is comfortable and palatable to investors at any given time. While we find magazine covers extremely useful, it is not because their advice is helpful, but to the contrary it reminds us of what market psychology has categorized as “certainty” and then forces us to think in a different direction, to think about what possibilities exist on the other side of that trade.
Why Magazine Covers Work?
Any editor worth his corner office is able to take all of the economic confluences that exist, both the lofty expectations and the latest disappointments, and distill them into one 9” X 11” glossy visage that evokes one thought from passersby: “I need to read what’s inside.” Typically, this is achieved by a strong confirmation of some generally accepted premise, or more importantly, rarely is it achieved by offering some innovative, against-the-grain, advice. Forbes magazine is no more likely to run a cover of who they think will be Company of the Year in 2014 today than Rolling Stone was to put Brittney Spears on their cover when she was a Mouseketeer. Instead, bullish covers often occur much closer to the landing than the takeoff of an investment flight.
A few years ago a group of professors at the University of Richmond, unbeknownst to us, actually tried to put some numbers to this observation. They looked at headlines from Business Week, Fortune, and Forbes for a 20 year period. Of the 2,080 cover stories they found, 549 were actually included in the study as they dealt with a particular public company for which the aftermath of the stock could be measured. Of those 549 stories, the vast majority (350) were slanted to the positive side, while 99 were considered “neutral” and 100 were “negative.” Keep in mind the time period was 1983-2002, which naturally lent itself to both bullish covers and bullish outcomes. At any rate, according to their research paper, “Are Cover Stories Effective Contrarian Indicators?,” Tom Arnold, CFA; John H. Earl, Jr., CFA; and David S. North found the following: “Statistical testing implied that positive stories generally indicate the end of superior performance and negative news generally indicates the end of poor performance.”
The study was very interesting and it makes a great piece of research to forward any friend or neighbor who suggests one of “those ideas” that is based in nothing more than popular conjecture and that more importantly isn’t supported by your investment game plan. The results of the University of Richmond show that bullish covers are born of spectacular outperformance, but followed by much tamer returns. Meanwhile, bearish covers actually tend to be followed by the opposite of what investors would expect — stark outperformance! ‘
This article was written by Dorsey Wright and Associates and provided by Charles Tumlin, Vice President – Investments, Wells Fargo Advisors, LLC, Beaufort, South Carolina, 843-524-1114. Investments in securities and insurance products are: NOT FDIC-INSURED/NOT BANK-GUARANTEED/MAY LOSE VALUE. Wells Fargo Advisors, LLC, Member SIPC, is a registered broker-dealer and a separate non-bank affiliate of Wells Fargo & Company.