Wednesday, July 23, 2008

How to use Market Forecasts: Do the Opposite

The following example is almost too good to believe.

On July 16, 2008, Jimmy Lathrop published an article on Seeking Alpha entitled: "Why I'm Committed to the UltraShort Financials ETF." I remember seeing the title of this article on the day it came out, and I thought to myself that I'd never seen the word "committed" used about any investment like that before. It struck me as a contrarian indicator. The charts within the article used the closing prices of July 15th, meaning it was probably written on the morning of the 16th at the latest.

I wish I'd had the conviction to follow through on my philosophy. On the day Lathrop's article appeared, the ETF in question (ticker symbol SKF) fell 20%. It has since fallen a total of 42%, taking SKF from it's all-time high of $203 on July 15th down to $117 today.

Market sentiment, such as one finds in the timing of articles like this, is primarily a short-term indicator, and not necessarily a forecast of long-term bear-to-bull market reversals, so this is not a critique of Mr. Lathrop. Financials may indeed start sliding again and reach new lows, meaning Mr. Lathrop's SKF call would end up with a net gain after all. However, I suspect that his article was inspired by some very strong feelings on his part (and everybody else's) after the huge financial sector losses (SKF gains) on July 14th and 15th - and this extreme sentiment is precisely why SKF "chose" that day to reverse course, if only temporarily. Every potential seller of financials was completely cashed out by that point, so there were no more sellers left.

Of course, it would have been more prescient if someone had written a similar article back on May 2nd, when SKF was trading for only $92, but that's just not how the market works. SKF was cheap then (financials were expensive) precisely because too few people were convinced that it should be otherwise. So the daily tsunami of financial commentary out there is very useful if you can surmise the consensus forecast and then do the opposite.


linc campbell said...

Committed may not have been a bad word to use though if he indeed is committed to holding SKF for another handful of months up to another year. I'd be surprised if $200 isn't a level of support at some point. Could he have made a smart short term move and sold then? Of course. But if he is truly committed to ride the trend...

...Financials are still in bad shape and IMHO there is a lot of bloodshed left to happen before it all shakes out.

linc campbell said...

With the recent bailout of Fannie and Freddie, the news of Lehman in such back shape and so much discussion of Wamu potentially being non-existent in less than 12 months, I'm curious what you would say about SKF since it has pulled back. It appears to be a declining trend overall despite all the band news. I wonder if the government came out and said there would be "no more bailouts, priod" if this would shoot up like a rocket.

Jody said...

Great question, Linc. You might be right that the prices in financials today reflect an expectation of more bailouts. This is the reason I'm reluctant to make forecasts in individual sectors - not only am I unsure what investors are thinking, but I'm even less sure of what the government is going to do!