Everybody is familiar with the colloquial term “Everybody is doing X.”
By “X” we don’t mean “formerly Twitter” — everybody has been writing “X (formerly Twitter)” so I thought I would do the opposite. In this case you’re welcome to fill in whatever you wish for X.
Salespeople often use the phrase to help sell products, especially new hot ones. Everybody uses the saying periodically, but of course we all know and accept that “everybody” is somewhat of an overstatement.
In the markets, when “everybody” is doing something, it often turns out to be the wrong thing, which raises the question: how could “everybody” be so wrong?
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In recent articles I demonstrated the inaccuracy of analyst projections on specific stocks, and I compared Wall Street expert predictions to Calgary amateur predictions. Both were examples of “everybody” getting it wrong.
The stronger the consensus, the more wrong it usually becomes. The reason is simply that when “everybody” thinks the market is going down, they have already sold or at least trimmed their stock holdings and have higher levels of cash. Most market participants think, erroneously, they can predict market direction. If they have a negative view, they are busy selling, driving the market down. When pessimism reigns, “everybody” is out, and the market runs out of sellers.
The American Association of Individual Investors (AAII) publishes weekly investor sentiment data. On Sept. 22, 2022, the sentiment read 17.7 per cent bullish, 21.4 neutral, and 60.9 bearish, rivalling the worst sentiment of the great financial crisis of 2008-09. The 2022 bear market bottomed shortly thereafter.
At year-end, sentiment remained dour, with 20.3 per cent bullish, 27.4 neutral, and 52.3 bearish. Additionally, Wall Street experts were almost unanimously predicting a 2023 recession with declining stocks.
When “everybody” thinks the market is going down (and this was as close to everybody as “everybody” gets), it must go up. The reason is simple: few sellers remain. When investors like me, who plod along buying what looks like good value, continue to buy, the market starts to move up. Then, as it starts to move up, other investors become more optimistic and start to re-employ the cash they built while selling. The market moves up more; others see the boat they are missing and buy; then, speculators and fast-buck artists jump in, driving prices to a crescendo. Markets peak when there is strong positive sentiment and with “everybody” in, few new buyers remain.
This isn’t an exact science. It just so happens sentiment and the market both bottomed at the same time during the 2022 bear market and also the 2023 market correction. Sentiment was lowest on Nov. 2, 2023, with 24.3 per cent bullish, 25.4 neutral and 50.3 bearish, coincident with the beginning of one of the strongest November/December rallies ever. However, all-time highs in January 2022 were predated by a sentiment peak a full eight months earlier, when there were 56.9 per cent bullish, 22.7 neutral and 20.4 bearish. Bullish or bearish sentiment can stick around for quite a while. I think sentiment picks bottoms better than tops, but if there are more than 50 per cent bullish for a prolonged period, something bad is likely to happen.
Grating against ratings
Analyst ratings of stocks are more nuanced than overall market sentiment. Analysts generally give individual stocks a one to five rating titled Buy, Outperform, Hold, Underperform and Sell, providing target prices.
The same principles apply in that widely touted stocks can often fall, and vice versa. If an analyst recommends a stock, portfolio managers buy it. The more analysts with a buy rating, the more funds have the company in their portfolio. It’s not unusual to see a stock fall five to 10 per cent simply on the downgrade from a well-known analyst, and vice versa. If it’s rated a buy, there is only one way for the rating to go, and that’s down. The nuance is that different analysts cover different stocks, the number of analysts covering a stock varies widely, and strong stocks can have positive analyst ratings for a long time.
A clear example of going against analyst ratings was recently in buying office properties. Boston Properties is a large office real estate investment trust (REIT) in the U.S. It peaked at $147 before COVID, fell then recovered to $132 in March 2022, then fell again all the way to $50 in November 2022, as work-from-home and commercial real estate debt woes dominated the sound waves.
I sold a put option (a bullish move) on it immediately after a BNN commentator banged the table to “stay out of office properties.” I had completed my financial review and was going to make a move, but that was the trigger. I then quickly followed up buying a Canadian office REIT, Allied Properties, for my RRSP. Boston Properties is up 40 per cent and Allied 30 per cent in the last couple of months.
Clearly, I didn’t make these decisions on one commentator. His comment simply encapsulated the dour sentiment on office properties.
A real challenge is to read repeated negativity and act differently — and, once again, vice versa.
