January 13, 2011

In this ever-changing world, there will always be new lessons to learn.

In the past decade, for example, Ive learned

• How to set up a wireless network.
• How to program my DVR remotely.
• How to use several types of GPS navigation systems.

Happily, there are some lessons that are no longer necessary for most people to learn.

• How to milk a cow.
• How to drive a stickshift.
• How to trim the wick in a kerosene lamp.

But some lessons are almost timeless, and will be learned for generations to come.

• Look both ways before you cross the street.
• Wash your hands.
• Be on time.

In the investing world, there are timeless lessons too, and the sooner you learn them, the better.

• Do not confuse the company with the stock.
• Do not confuse price with value.
• The stock market can remain irrational longer than you can remain solvent.

Compound interest is the eighth wonder of the world.  (See my December 20, 2010, issue). so the sooner you start investing the better.

And-the main topic of this column-it pays to be contrary, as the market rides the unstoppable waves of the human emotions of fear or greed.

Think back, for example, to the spring of 2009, when the financial news was so terrible that people feared massive bank failures, as well as a huge wave of commercial mortgage defaults that would follow the residential mortgage crisis.  Fear was rampant then and it was an excellent time to buy stocks.

Contrarily, early 2000-when the worlds computers had survived the millennial changeover and stocks were shooting through the roof as pundits touted the wonders of the New Economy-was an excellent time to sell stocks.

In hindsight, we can see how each of these periods was characterized by extreme mass emotion, and we can recognize what effect those emotions had on stocks.

But can we do it in real time?  The answer-to some extent-is yes.  And heres a chart that can help.

Published in 2003 by Sy Harding in Street Smart Report, a first-class market-timing service, this chart provides a handy roadmap of the sentiments of the average investor as markets evolve.

Ive kept a copy at hand since I first saw it, and I refer to it occasionally, asking myself where we might be now in the sentiment cycle.  So take a look.  Where are we now?  Were certainly past stage 5 in the bull market.  Maybe were at 7.

In any case, the major top wont come until sentiment hits 10.  And that could be months away or years away.  Which means there are likely to be substantial and numerous corrections on the way there.

But things are certainly heating up, as evidenced by the Facebook/Goldman Sachs deal this month, as well as todays news that a cupcake company-Crumbs Bake Shop-will have an IPO soon.  And as emotions improve, along with economic news, it will pay to keep this chart in mind so that when the next big bear market does begin, you can resist the cheery groupthink and take action to preserve your profits.

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