5 Things To Ponder: The "Howard Mark's" Problem

Howard Marks once stated that being a "contrarian" is tough, lonely and generally right. To wit:

"Resisting – and thereby achieving success as a contrarian – isn't easy. Things combine to make it difficult; including natural herd tendencies and the pain imposed by being out of step, since momentum invariably makes pro-cyclical actions look correct for a while. (That's why it's essential to remember that 'being too far ahead of your time is indistinguishable from being wrong.')

Given the uncertain nature of the future, and thus the difficulty of being confident your position is the right one – especially as price moves against you – it's challenging to be a lonely contrarian."

The problem with being a contrarian is the determination of where in market cycle the "herd mentality" is operating. The collective wisdom of market participants is generally "right" during the middle of a market advance but "wrong" at market peaks and troughs.

This is why technical analysis, which is nothing more than the study of "herd psychology," can be useful at deteriming the point in the market cycle where betting against the "crowd" can be effective. As Howard Marks stated, being early is the same as being wrong.

As I penned yesterday:

"As of the end of May, all internal measures of the market are throwing off warning signals that have only been seen at previous major market peaks.

These "warning" signals suggest the risk of a market correction is on the rise. However, all price trends remain within the confines of a bullish advance. Therefore, portfolios should remain tilted toward equity exposure "currently."

The mistake that most investors make is trying to "guess" at what the market will do next. Yes, the technicals above do suggest that investors should "theoretically" hold more cash. However, as we should all be quite aware of by now, the markets can "irrational" far longer than "logic" would suggest. Trying to "guess" at the next correction has left many far behind the curve over the last few years."

This is the "Howard Mark's" problem defined. There are plenty of warning signals that suggest that investors should be getting more cautious with portfolio allocations. However, the "herd" is still supporting asset prices at current levels based primarily on the "fear" of missing out on further advances. Becoming too cautious, too soon leads to "emotionally" based decision making which generally turns out compounding the problem.

Furthermore, at TRUE market peaks, there are generally very few "bears" in existence. Currently, as this weekend's reading list shows, there are probably too many "bearish" opinions on the market currently. As a Mr. Marks suggests, being a "contrarian" is supposed to be a tough and lonely existence.

1) Prechter Warns Of Sharp Collapse In Stocks by Tomi Kilgore via MarketWatch

"Based on Prechter's analysis of where the stock market is positioned within its wave structure, he believes the bull market is in a "precarious position."

For one, he said the sentiment indicators he follows have reflected extreme optimism for over two years. That is often viewed as a contrarian signal, because it suggests those looking to buy have already done so, leaving fewer buyers to step in if the market starts slipping.

In addition, Prechter said a number of momentum indicators have been revealing a "dramatic lessening" in the number of stocks and indexes that have participated in the rally in recent months."

Read Also: 103 Years Later, Nothing Has Changed by Tyler Durden via ZeroHedge

2) Stocks On The Wrong Side Of Rate Hike History by Lu Wang & Jennifer Kaplan via BloombergBusiness

"Never before has a rally in the U.S. stock market gone on this long without a Federal Reserve interest-rate increase. Expecting valuations to keep rising once one comes is asking too much, if history is any guide."

Read Also: Fear & Loathing In The Financial Media by Ben Carlson via Wealth Of Common Sense

3) The Bears Wake Up by Cam Hui via Humble Student Of The Market

"When the FOMC begins to raise short-term interest rates, this will occur in a very different environment than in the past. Reserves in the banking system are very plentiful, reflecting the large increase in the Federal Reserve's balance sheet over the past few years. But this circumstance should not adversely affect our ability to push the federal funds rate into a higher target range. We have the appropriate tools to push up short-term interest rates. However, lift-off may not go so smoothly in terms of the impact on financial asset prices. After all, lift-off will represent a regime shift after more than six years at the zero lower bound."

Read Also: I Can't Find Anything To Buy by David Merkel via Aleph Blog

4) Stocks Defy The Trend In Fund Flows by Bryce Coward via GaveKal Capital Blog

"The trend in mutual fund flows is starting to get ugly. In the chart below we show the one year moving sum of flows into equity mutual funds (red line, left axis) and then overlay the S&P 500 price (blue line, right axis). By this measure, flows into equity funds peaked out in early 2014 and net inflows have turned to net outflows."

Read Also: The S&P 500 Is Approaching The "Zone Of Death" by T. Erik Conley via MarketWatch

5) The Average Stocks Is Already Falling by Michael Kahn via Barron's

"But the S&P 500 tracks big stocks, and is capitalization weighted. The bigger the stock the more it counts, and that can mask small stock weakness. Tech behemoths such as Apple (ticker: NASDAQ:AAPL ) and banking giants such as JP Morgan Chase ( NYSE:JPM ) are indeed doing a lot of the heavy lifting. To combat this problem, I like to look at the New York Stock Exchange composite index as the champion of the average stock. True, it still does favor larger stocks, and it includes non-domestic stocks such as bond funds and foreign shares, but the sheer number of issues contained dilutes their effects.

Warts and all, the NYSE composite gives me another angle on market breadth. And right now, it has moved below short-term trendlines drawn from the October 2014 closing low."

Read: This Is Inflation by Jeffrey P Snider via Alhambra Investment Partners

BONUS READS & STUFF

Stocks Are Not Cheap Relative To Bonds by John Hussman via Hussman Funds

Peter Schiff Warns On Market Bubble by Peter Schiff via Euro Pacific Capital

How To Measure Risk by Howard Marks via Barrons

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