It Pays to Go Against the Crowd

Small investors have an abysmal track record when they try to time the market. That applies to both stocks and commodities.

Recent mutual fund money flows show that Mom & Pop were large net buyers when stocks were flying high. They turned into net redeemers only after equities sunk in late January.

By Wednesday, Feb. 4, 2015, as the market bottomed the public was selling at a $9 billion per week clip. Their collective wisdom cost them a ton of money when all January’s losses were made up in just one week. By Valentine’s Day the S&P 500 had made a new all-time high. Like clockwork, the surge was enough to get individual investors to start buying again. Heavy net selling at low prices gave way to billions in new purchases at much higher levels.

Crowd behavior works or, more accurately, has not worked, the same way with the topic of the day, oil prices.

‘Short Selling’ is nothing more than borrowing an asset while selling it, with the idea that you can buy the same thing back later at a lower price. There is always some level of short selling going on due to professional hedging activities.

Paying attention to deviations from normal is the key consideration. Over the past seven years the S&P Energy Sector Short Interest typically cycled between 4.5% and 7.0% of the total float.

A chart of that data along with the corresponding price action in crude oil shows that speculators have been wrong at almost every key turning point. Short sellers become emboldened only after big declines and often get caught covering for losses.

2015’s incredible rise in Energy Sector short interest, to almost 10%, was unprecedented in both magnitude and correctness until recently. The further from normal things got, the more pronounced the eventual rebound. Moves like this year’s end typically abruptly with 180-degree reversals.

The 2009 through early 2011 period illustrates how painful it can be for the shorts.

Once everybody was sure oil could only go down … it reversed with a vengeance. Oil & gas stocks and funds surged by almost 6% in the week ended Feb. 6, 2015. They tacked on another 2.55% over the next seven days. Both weeks saw energy-related mutual funds among the best performers.

Real money is rarely made by following the crowd. To do better than most other investors you must act differently than they do. Fight your emotions and buy out-of-favor funds to achieve outsized returns. Last year’s big winner was the stodgy utilities group. By the end of 2014 they had gotten grossly overpriced. It’s no surprise that utility funds and ETFs occupied the bottom of the rankings in the two weeks ended Feb. 13, 2015.

The Bottom Line

The moral of the story? Don’t chase yesterday’s hot funds. Recent laggards often turn into tomorrow’s winners.