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Read All About It! How to Handle Front-Page Risk

As a former daily newspaperman, I tend to romanticize newspaper movies. The epitome of the genre is His Girl Friday, a 1940 screwball comedy starring Cary Grant and Rosalind Russell. They play fast-talking, wisecracking reporters who will do anything to get a story. It’s based on the stage play The Front Page.

Front-page headlines, many of them alarmist and hyped, have been driving stock market behavior lately.

Most people move in groups. They typically buy after prices have already risen and sell after prices have already fallen. Hence the power of headlines.

The markets are closed today for the Good Friday holiday. The first quarter of 2018 is officially behind us. As we look back on Q1, we see that it was turbulent and nerve-wracking. Headline risk has made a comeback. The slightest whiff of bad news, or an impulsive tweet from President Trump, can send stocks reeling.

The Facebook/Cambridge Analytica scandal has weighed heavily on the so-called FAANG stocks: Facebook (NSDQ: FB), Apple (NSDQ: AAPL), Amazon (NSDQ: AMZN), Netflix (NSDQ: NFLX), and Alphabet’s (NSDQ: GOOG) Google.

All five FAANG stocks have experienced sharp declines over the past few weeks, although they ended the trading session Thursday in the green on the strength of positive economic data.

Caught in Facebook’s web…

When the markets open on Monday, you can probably expect one company (and its peers) to fall serious victim to headline risk: beleaguered Facebook. The social media giant got some very bad news coverage today.

An explosive Facebook internal memo leaked to the press Friday defended the company’s strategy, even if it got people killed.

Here’s a salient excerpt from the memo, which was written by a Facebook executive in 2016:

“We connect people. Period. That’s why all the work we do in growth is justified… That can be bad if they make it negative. Maybe it costs someone a life by exposing someone to bullies. Maybe someone dies in a terrorist attack coordinated on our tools. And still we connect people.”

Yikes. That’s shockingly amoral, even for a Silicon Valley techie. The Facebook fallout is likely to weigh on the entire tech sector.

Facebook deserves a bearish assessment right now. But innocent tech firms will get tarred with the same brush. Investors who hold intrinsically sound tech stocks will be tempted to dump them. That would be unwise.

By following my advice below, you can learn to recognize the extremes of crowd behavior and make investment plays against it.

The Dutch financial bubble…

Charles Mackay, in his 19th century classic economic book, Memoirs of Extraordinary Popular Delusions and the Madness of Crowds, aptly describes the tendency of investors to behave like lemmings. Consider his account of “Tulipmania”:

“In 1593, no Dutchman had ever seen a tulip. Their beauty and rarity caught the national fancy. In no time, they became ‘the rage’ as aristocrats flaunted the exotic flowers as symbols of power and prestige… Though supplies could be increased only as fast as nature allowed, demand for tulip bulbs accelerated at a fevered pitch.

Soon all tiers of Dutch society were swept up in a tulip-trading craze that peaked in the 1630s, selling ‘futures’ on crops not yet grown or harvested. In the end, crops of bulbs still in the ground were bought and sold so many times that the sales were called the ‘Wind Trade’ (as the speculative prices were being made up out of thin air).

After the market crashed in 1637, bankrupting many, the era came to be known as ‘Tulipmania’ or ‘Tulipomania.’ ”

In the above passage by Mackay, substitute “tulip” for “social media IPO,” and you come to the sinking realization that nothing has changed over the last four centuries. To avoid getting sucked into similar investment fads, here are the top contrarian indicators that you should watch:

  • The mainstream business press is repeating the same talking points about the same trend.

The talking heads on media venues such as CNBC often aren’t financial experts; typically they’re generalists and performers who glibly encapsulate the common consensus. For example, if a neatly coiffed pundit is warning about the imminent dangers of XYZ, it probably means that the dangers of XYZ have already reached a peak and these fears are now overblown.

  • A fundamentally strong company is unfairly getting beaten up in the press and by analysts, driving down its stock price to unjustified lows.

If a certain company is getting a lot of bad press for a misstep, sending its stock into free-fall, it could be a great buying opportunity. Take a look at the company’s fundamentals. If the company makes a good product that people will continue to need far into the future and its fundamentals are strong, you should consider making an investment. Bad press tends to be ephemeral. A disciplined contrarian investor is continually on the prowl for “out-of-favor” stocks.

  • A fundamentally weak company is riding a wave of positive publicity.

The converse of the above rule also is true. People, with all of their irrationality, are what move markets. A company that’s benefiting from a lot of hyperbolic press coverage might have poor fundamentals and be ripe for a fall.

This dynamic is especially pronounced in the technology sector, whereby Silicon Valley companies announce sexy new gadgets that capture the fancy of consumers and local newscasts. Often lost in the gee-whiz coverage is the company’s unsustainable debt or lousy earnings prospects.

  • The mood of investors is persistently gloomy.

If the stock market is bearish and everyone is regarding stocks the way Superman regards Kryptonite, a new bull run may be imminent. When investors are unanimously gloomy, prices can only go up.

  • The stock market is on a dizzying upward trajectory, fueled by euphoria.

When everyone and his brother is buying stocks and dishing out hot stock tips, it’s a clear sign that a top is near. Case in point: the Trump rally has become the Trump slump.

Investors usually buy when they anticipate the market will rise; they sell when they anticipate the market will fall. But if everyone is expecting prices to go up, odds are that everyone who intends to buy already has bought. So, who’s left to bid prices up? The Dutch learned this lesson the hard way.

My advice: Generally speaking, if you consistently buy during times of unreasoning fear, and sell during times of euphoric greed, you’ll do well.

Got any questions about the recent market correction? Drop me a line: mailbag@investingdaily.com

John Persinos is managing editor of Personal Finance and chief investment strategist of Breakthrough Tech Profits.

 


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