A study on the stock market concept of Magazine Theory

In a study of major news magazine covers since the 1920's, Paul Montgomery, a very astute analyst, found that for about 30 days after a bullish or bearish cover, the market's performance was usually consistent with the cover. In fact, if you had invested in the stock market for the 30-day periods following the cover stories, your investment would have gained at a rate of about 30% per annum, thus showing that cover stories have tended to occur near points of maximum momentum on the upside or the downside. BUT, while the covers had been right for 30 days, it was found that they have been wrong over the subsequent 11-month periods more than 80% of the time. BY GOING CONTRARY TO THE MAGAZINE COVERS AFTER 30 DAYS, YOU WOULD HAVE BEATEN THE EQUIVALENT BUY-AND-HOLD RETURN BY ABOUT 500% OVER THE NEXT 11 MONTHS!

Did you see the March 26, 2001 covers of Newsweek and U.S. News? Newsweek says, "The Economy: How scared should you be?" and "The Market's Wild...Confidence Is Shaky...What You Can Do Now." U.S. News says, " BEAR TRAP...Will tech stocks sink the rest of the market-and the economy?" It reminds the Gorilla of the Sports Illustrated jinx in the sporting world. That's another story.

To better understand how contrary opinion operates, Mr. Montgomery says, think of money as financial liquidity. And think of an extreme in liquidity as the direct opposite of an extreme in psychology. If everyone decided that the Dow Industrials would rise to 5000, for instance, they would rush out and buy stocks. Everyone would become fully invested, the market would be overbought, and nobody would be left to buy, in which case the market wouldn't be able to go any higher. When optimism is extreme, liquidity is low.

On the other hand, if everyone was pessimistic and thought the Dow would drop to 1500, the weak ad nervous stockholders would sell, the market would be sold-out, and nobody would be left to sell, in which case the market wouldn't go down anymore. Whereas increasing optimism and confidence produce falling liquidity, rising pessimism and fear result in rising liquidity.

Another way to look at contrary opinion is to compare stockholders to nuts in a tree. An investor once wrote, asking "how do you get nuts out of a nut tree?" The answer, he said, is through a nut-shaking machine, which would be hooked to the nut tree. The machine would rattle the tree, and the nuts would drop until all of the nuts had fallen out. In other words, when there's enough fear in the market, all of the weak holders are shaken out, and there's no selling left to be done. "Have the nuts been shaken out," the contrarian asks, "or are all of the speculative traders fully invested?"

This theory was written in 1971! According to the theory, after about a 30 day "dip," the market should run like crazy by the end of April, for about the next 11 months! Many analysts believe this theory, especially hedge fund managers who are even more sensitive to quick market moves. However, in case the "dip" doesn't come, and we are close to the "turning point," and the market rallies in April, it is probably a good idea to start chipping away at these levels now.