Yesterday we took a pretty broad look at a few of the major stock market indexes from a technical perspective. Today I’d like to run through a similar process looking at sentiment. But first I should probably take a step back and discuss sentiment more broadly. Obviously, most folks understand the value in looking at valuation, analyzing balance sheets and income statements and how they relate to shares outstanding and stock prices. That’s what they teach you in business school and it’s pretty fundamental to the investment process. I guess that’s why it’s called “fundamental analysis.”

But as soon as you step outside the area of “fundamental analysis” folks start to turn up an eyebrow. Technical analysis and sentiment research aren’t taught in business school. Technical analysis, or chart reading, seems like some sort of voodoo and sentiment research may be too touchy feely. Isn’t that what your therapist is for? Exploring your emotions? I understand this reaction. For years I ignored them both and to my own detriment. After studying both for a long time I’ve realized they are absolutely necessary to forming a holistic view of the markets. And each should have an important place in an investor’s repertoire.

To be honest, I never really ignored sentiment study. It is and always has been a deep part of who I am. I have never like crowds. As a baby, I used to throw up when my mom would take me into any crowded environment. Still to this day I can’t stand going to the movie theater. And this aversion affects my investing to a great degree both positively and negatively. On the positive side, it’s kept me out of the stock market during the internet bubble when everyone and their mom became an expert internet stock day trader. On the negative side, I have a hard time riding a trend. Once other investors start to embrace something I start to get worried and this has caused me to sell too soon on more than one occasion.

We are human beings which means it is impossible for us to be perfectly rational at all times. And most people are not like me. In general, they can’t stand to own something that is hated and they love owning something that is idolized or admired. Look back at the internet bubble or the real estate bubble and think about how many people you knew who got caught up in them. What was the talk at the dinner parties you went to at the time? I clearly remember going to plenty of parties where people weren’t asking me, the expert, for advice; they were telling me how I was missing out on “the opportunity of a lifetime.” It just feels more comfortable to do something when everyone else is doing it. On the flipside, it’s much more difficult to do something when nobody else is willing to do it with you. But both of these areas are where the best opportunities lie.

You can spend lifetimes analyzing why these things are true but for our purposes it’s enough to just accept that they are using our personal experience as proof. And it pays to understand how they can hurt you or help you in your investing activities. If there’s a lesson in the bubbles of the past 15 years or so, and it should be damn clear to everyone by now, it’s ‘when everyone else has already embraced an investment idea it’s probably reached the point at which it is no longer very attractive.’ This lesson can be applied to every investment decision you make by asking, ‘at what stage of acceptance are we currently at with respect to X,’ with “X” being whatever you are analyzing at the time.

Generally, it’s better to buy something when it’s feared or hated rather than when it’s loved for two reasons. First, when something is feared most folks won’t own it. That means the whole world is potentially a buyer of what you own. When something is universally loved, like Apple’s stock was last Fall, there are simply no buyers left out there in the world to push the price higher or to even support the current level. Second, when something is hated it’s much more likely to be bought at a bargain. Conversely, when something is loved sellers can usually demand a premium price. This is why Warren Buffett likes to say, “be greedy when others are fearful and fearful when others are greedy.” For him it’s all about price and fear creates the bargains he lives for.

To analyze sentiment is to enhance your understanding of value. If stocks are fairly priced but everyone is in love with the fact they own them then they instantly become less attractive to someone like me. And if stocks are fairly priced but everyone hates them they may present a much better opportunity than they appear initially. It’s no coincidence that I believe stocks are, indeed, fairly valued today. The fundamentals are not telling me it’s time to buy or time to sell so this makes sentiment all that more important. Tomorrow we’ll take a look at a variety of sentiment indicators to see what investors

Chart of the Day

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Apple bounced off of its weekly uptrend line today and started to make some progress towards forming that technical bottom I mentioned on Monday.

Hit the Links

  • Junk Bonds Are “Completely Out of Control” And “Equities Are Still Being Disrespected” (Distressed Debt Investing)
  • Bargain Hunting at J.C. Penney (ContrarianEdge)
  • 10 Most Hated Companies in America? J.C. Penney Makes The List (The Big Picture)
  • Tom DeMark says “the bottom is in” for Apple’s stock price (CNBC)
  • Apple supplier sees significant sales increase in Q4, likely positive sign for iPhone 5 demand (MacDaily)
  • Apple (AAPL) Now 32% Below Price Target (Bespoke)
  • If DeMark Is Right About Apple, Its Insanely Bullish for the Large Cap Indices (Phil Pearlman)
  • “What’s it for?” The value of considering profit versus purpose (Seth Godin)
  • The Story Of A Man Who Outsourced His Work To China So He Could Watch Cat Videos All Day (Business Insider)
  • American Single-Malt Whiskeys Serve Notice (NY Times)
  • The 100 Most Beautiful Songs in the World, According to Reddit (Mashable)
  • That Loving Feeling Takes a Lot of Work (NY Times)