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Humans are Bad Predictors of Market Returns

Humans are Bad Predictors of Market Returns

| May 23, 2022

The term "contrary indicator" is not a term of flattery.  It refers to that friend or acquaintance who tends to be on the wrong side of trends.  Late to the party, so to speak.  Zigging when they should be zagging.

That friend isn't just one person, however. It is all of us, and we are collectively horrible at timing.  We humans are that contrary indicator, and it's a pretty good bet that when we are ready to throw in the towel, it's a a decent time to be a buyer.

Our friends at Congress Wealth Management in Boston put together some graphics and figures that make this point:  When indicators of investor pessimism are at their most extreme (worst 10% of observations), future returns tend to be far better than average.  

Their composite of five indicators reached extreme pessimism a week ago when all five were in the max negative range.  This is a rare occurrence, happening only 0.5% of the time.  And as the table below shows, from such points of negativism, the S&P500 has posted an average 12-month return of 28%. 

This, of course, does not say that there might not be better buying points. (The financial crisis of 2002-09, for instance, provided many entry points as the S&P500 eventually declined by more than 50% at its worst.)  But barring  an outcome that extreme, it does say that history is on your side when stepping in front of a very negative tide.