COVER STORY “SECRET” REVEALED-KISS OF DEATH OR RALLYING CRY? (CLICHÉ ALERT AHEAD)

An interesting idea has been bouncing around financial circles, perhaps due to a recent article in the Financial Analysts Journal (a publication of the CFA Institute). The article, “Are Cover Stories Effective Contrarian Indicators?” written by Tom Arnold, CFA, John H. Earl, Jr., CFA and Davis S. North. The basic finding of the work is stated in the Abstract:

Headlines from featured stories in Business Week, Fortune, and Forbes were collected for a 20-year period to determine whether positive stories are associated with superior future performance and negative stories are associated with inferior future performance for the featured company. “Superior” and “inferior” were determined in comparison with an index or another company in the same industry and of the same size. Statistical testing implied that positive stories generally indicate the end of superior performance and negative news generally indicates the end of poor performance. [Emphasis Added]

This contrarian relationship has been noted by the Author’s primary investment source, Dorsey Wright & Associates. (DWA). The May 1, 2007 daily letter “From the Analyst” states in the headline that the “Magazine Indicator [is] at Work Again.” The DWA approach to the Cover Story Contrarian Indicator is set out below:

One of the indicators that we have found to be very useful over the years is the “magazine cover indicator.” For those of you that are not as familiar with the magazine cover indicator, our observation has been that whenever something finally makes it to the cover of a magazine the move has typically run its course and the stock or sector is ready to head in the other direction. So, if we see a positive magazine cover, the stock has typically had a great rally already to get to such a position. After the cover is launched we often see that everyone who wants to be in, is in, and the rally slows or even reverses. Conversely, if the cover is negative on a stock or a sector, meaning the move down is exaggerated enough to warrant the attention of the magazine editors, most everyone who wants to sell has sold. As a matter of fact, we subscribe to dozens of different magazines, so we are always getting new magazines in the mail. We teach every new intern that comes in the office to graciously take the mail from the mailman, and once the intern has identified a magazine from the pile, and offered his thanks to our local letter carrier, we then teach them to tear the cover off and throw the rest of the magazine away. We do this because the only thing that we are concerned with is the actual cover, which is where the real story is.

The DWA letter gives some examples. An interesting case was General Motors (GM). The February 2006 cover story was entitled “The Tragedy of General Motors”. While many commentators were expecting Chapter 11 and looking for a good deal on a Silverado, GM had a 64% return in the following year. The S&P 500 had a 13.4% gain in the same period. Not bad for Detroit.

BUT DON’T BET THE FARM ON POSITIVE OR NEGATIVE INK

While the Author is digging through piles of last year’s magazines, he advises that an investor should not adopt the Cover Story Indicator as one’s main investment methodology. Still, it does illustrate a common contrarian indicator, “that when everybody’s buying, its time to sell.” Running against the herd. Beating the bigger fools to the door. Or as was most eloquently stated by Lord Keynes and Jeremy Grantham, in an earlier Desert of the Real post:

The central principle of investment is to go contrary to the general opinion, on the grounds that if everyone agreed about its merits, the investment is inevitably too dear and therefore unattractive.

This statement reflects the central theme of capitalist markets, as stated often by Jeremy Grantham of GMO LLC.

“[E]conomic trends mean revert because there is a powerful and persistent normal return toward which capitalist competition strives, competing down handsome margins and P/Es and avoiding low returns until shortages develop.”

NEW CONTEST QUESTION

Last post’s prize went unclaimed. In that post, “Goggle Bubble”, the Author noted that the South_Sea_Tulip_Genome.com Fund invests in biotechnology and Britney Spears Commando Shot futures. The question was how can this obscure yet risqué pop culture reference relate to the financial futures market?

Here’s how. Hypothetical investors could purchase futures on when and where will Britney Spears next appear in full Commando. It would be a little like betting on a sporting event. Sporting men watching for a sporting woman.

This post’s question is:

In what year did the War of 1812 end?

There are arguably two “correct” answers to this question. So if you want to win, you must state why you choose a certain year. The winner can choose from a ticket and a soda at the Guild Cinema in Albuquerque, a plate of the best huevos rancheros in Albuquerque at the Central Avenue Village Inn, or a gift certificate for $10.00 at a restaurant of the winner’s choice. Travel expenses to Albuquerque are the sole responsibility of the winner. Email your responses to: desertoftherealeconomics@hotmail.com.

IT HAS RAINED THE PAST TWO DAYS IN THE DESERT OF THE REAL. FLOWERS WILL BLOOM THAT HAVE BEEN DORMANT SINCE 1996.


IMPORTANT DISCLAIMER: This newsletter is offered for informational purposes only. Sources of information provided are believed to be reliable, but are not guaranteed to be complete or without error. Opinions and suggestions are provided with the understanding that readers acting on information contained herein assume all risks involved. The Author may or may not buy or sell securities discussed in this newsletter.