Wednesday, June 05, 2013

Investing and Trading on Media Indicators

As soon as USA Today ran with the “Bull run gets solid footing” headline, I knew it was only a matter of time before the market sold off.


History, my dear Watson… History.

Shortly after this cover story ran on May 29, 2013, the market dropped about 300 points.

When Barron’s released its “Time to Buy” cover in October 2011, I knew it was time to go short both financials and the overall market.

And it’s a good thing I did. The market would fall 250 points the following week, led in part by financials.

You see, magazine covers have a history of leading investors astray.

The findings of three University of Richmond professors published in their recent study “Are Cover Stories Effective Contrarian Indicators” prove as much.

Their research examined Business Week, Fortune, and Forbes, and found a correlation between the cover of the publication and the performance of a stock.

In addition, the study examined how covers can predict when the overall market would change. (See the examples below.)

Business Week’s August 13, 1979 “The Death of Equities” cover claimed investors – burned by years of bad returns in the 1970s – turned their back on stocks for good. That was just before the market launched into an 18-year rally.

Times’ “Home Sweet Home” cover story in June 2005 called the very top of the housing market. Newsweek’s April 2010 cover declared “America’s Back!” right before the Dow plunged from 11,200 to about 9,500.

Here’s the September 1998 Time cover asking, “Is the Boom Over?” before the Internet bubble even started to inflate.

Dozens of covers have been directly linked to changing the course of market direction:

In the March/April 2007 Financial Analysts Journal, Arnold, Earl and North take the issue head-on. They collect 20 years of headlines from Business Week, Fortune and Forbes and classify them as positive, negative or neutral.

Their statistical tests indicate that positive cover stories typically signal the end of superior performance and that negative headlines typically signal the end of poor performance. However, the evidence does not strongly suggest significant reversal or momentum when factors such as company size are also considered.

It may sound like a ridiculous indicator, but it holds true.

By Ian Cooper of the Speed Retirement System