The internet has changed the way investors consume stock market news. There is a surplus of investing information out there now, all jockeying for your attention. However, one thing that hasn't changed is the magazine cover story as a sentiment indicator. Today, we're going to discuss how a contrarian trader can profit off these cover stories.
This piece is not meant to deride news publications for poor content. The purpose of cover stories are, quite simply, to report the news. They want to attract your attention. Their priority isn't to gauge what a stock will do in the coming months; their priority is to report on what is newsworthy at the time.
As a result, when you read a cover story in The Wall Street Journal or Forbes, that trend is likely already widely known, universally accepted, and has been in place for a relatively long time. This is especially the case when a general interest news outlet, such as Time, touts the bullish or bearish case for a particular stock.
Given the rapid flow of information through the market, contrasted with the sluggish nature of print publications, we've found that cover stories -- both bullish and bearish -- most often coincide with the culmination of a trend, rather than its inception. By the time a positive or negative outlook for a given stock, commodity, or asset class is a topic of broad enough interest to command real estate on a magazine cover, it's more likely than not that traders have already priced in the same information discussed in the cover story.
Let's consider how this fits into the "sentiment cycle" sequence. The sentiment sequence off a major bottom (whether for a single stock, or the broader market) can be described as: despair; disbelief; acceptance; and euphoria. Off a major top, the sequence goes: euphoria; disbelief; acceptance; and finally, despair.
The "despair" stage tends to mark a bottom. When "everyone" is bearish, selling pressure has been exhausted, and the next major move is likely to be higher.
Meanwhile, initial rallies off a market bottom -- as well as the initial declines off market tops -- are greeted with "disbelief." Eventually, the new direction for the market becomes sufficiently established and sentiment enters the "acceptance" stage.
And then, of course, the next stop is "euphoria," which often marks a top, as buying power is nearly exhausted and the next major move is down.