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Green Light for a Market Comeback

It's a sad but true statement: If you can count on the collective actions of investors to do anything, you can count on them to get it wrong time and time again.

While it would be nice to imagine that the stock market is an objective, dispassionate barometer of economic health, on the individual level, investors are frequently irrational and emotional, making decisions that aren't in their best interest. Now is no exception.

Contrarian movements
Consider: When do we see the most inflows into the market? Historically, that has been during good times, especially toward the peak of the business cycle. When the market heads south and people are scared, asset flows dry up as investors cut back their equity allocation. Unfortunately, the masses tend to move into and out of the market at exactly the wrong times, which makes for a fairly reliable contrarian indicator.

According to research from Bespoke Investment Group, consensus recommendations for stock allocation from Wall Street analysts reached a peak of 72% back in 2001, just after the peak of the stock market. As the bear market intensified, analysts dialed back their recommended exposure. Investors following that advice would have partially missed out on the rebound that began in 2003.

In the face of today's bear market, analysts are again reducing their recommended equity exposure, which has fallen to a nearly 10-year low of 58%. When the market was at similar levels back in 2003, stock allocation was at 68%. That's a very good sign for contrarians: When people are scared and running away from stocks, smart investors know to be opportunistic.

Follow the smart money
But don't just take my word for it -- some of the smartest minds in the business are trolling through the wreckage of this market turmoil and picking up some of the pieces. All-star mutual fund manager Ken Heebner turned bullish on financials last fall and built up large positions in names such as Citigroup (NYSE: C  ) , Bank of America (NYSE: BAC  ) , and Prudential Financial (NYSE: PRU  ) . (Although Bloomberg just reported that Heebner has recently exited his Citigroup and Bank of America positions.)

Heebner is joined by Ron Muhlenkamp, who initiated a position in Morgan Stanley (NYSE: MS  ) in the fall and whose recent top holdings included beaten-down conglomerate General Electric (NYSE: GE  ) . Fairholme manager Bruce Berkowitz has made concentrated bets on health-care picks Pfizer (NYSE: PFE  ) and UnitedHealth Group (NYSE: UNH  ) . 

We all know the market is a scary place right now. The odds are good, too, that we may not have reached a bottom just yet. But history has shown that when investors begin to panic and flee stocks, that's a pretty good time to be thinking of getting into equities.

That Wall Street analysts are more bearish on stocks than they've been in more than a decade is an excellent clue that a lot of that fear is already priced into the market. Excessive investor pessimism equals opportunity for those willing to tread into uncertain waters.

If you want to get a closer view of how some of the smartest people in the market are positioning their portfolios in today's market, look no further than the Fool's Champion Funds investment service. We've got the inside scoop on the best mutual funds in the business, run by some of the top names around. In an environment filled with uncertainty, more and more investors are realizing the value of having a helping hand in making their investment decisions. You can check out the service with a free 30-day trial today.

I'm not going to go out on a limb and say we've hit bottom yet, but I do believe the widespread negativity in the market is a good indication that a turning point is near. So don't cut back on equity exposure now. This is the time to stock up on investments that have great long-term prospects, so keep your eyes peeled!

Amanda Kish heads up the Fool's Champion Funds newsletter service. At the time of publication, she did not own any of the companies mentioned herein. The Motley Fool owns shares of UnitedHealth Group and Pfizer. UnitedHealth is a Motley Fool Stock Advisor and Motley Fool Inside Value selection. Pfizer is an Inside Value and Income Investor recommendation. Muhlenkamp and Fairholme are Champion Funds picks. Click here to find out more about the Fool's disclosure policy.

Read/Post Comments (12) | Recommend This Article (62)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 13, 2009, at 4:10 PM, jeffduby wrote:

    Instead of looking at widespread negativity, that tells you that the bottom is near, how about looking at retail numbers, auto sales, employment numbers, consumer confidence data, housing prices, construction data, weekly and monthly charts.

    This data tells me that the bottom is not even close. There may be some light in refiners and precious metals, but thats about it.

  • Report this Comment On February 13, 2009, at 7:12 PM, rfaramir wrote:

    The nice, hard data you're looking for are only seen in the rear-view mirror. It'll be too late to act on them, in terms of purchasing stocks. The stock market's disadvantage is its emotionality and irrationality, but the corresponding strength is that it ends up leading the actual economy when a recovery happens.

    Thus you have to buy stocks when pessimism at maximum "widespread negativity", because they'll be already up a large distance before you see any hard data.

  • Report this Comment On February 17, 2009, at 6:10 PM, SteveTheInvestor wrote:

    Jumping in on widespread negativity is a nice thought in theory. The other side of the coin though is that the negativity could continue for quite some time. This is a consumer economy and the consumer is nowhere to be found. They are off somewhere trying to figure out how to pay their debts and/or where they are going to live when they lose their house.

  • Report this Comment On February 17, 2009, at 6:20 PM, CoastalTrader wrote:

    It's passed time. I have personally twice changed the light bulb on the green light,

  • Report this Comment On February 20, 2009, at 1:31 PM, tinybit wrote:

    I appreciate the article. However, it is time to stop the buul....This is no time to be a speculator.

    In many ways the economy is more dire than in the thirties because the world is so tied together. There is not a country on any continent that has been spared or has the ability or knowledge to 'jump start' the economies. Japan will bring down the Asian sectors, Venezuela and others will tear down the South American region, the East European and Russian economies will be a drag on the European continent. I have never been as pessimistic as I am now and I am almost seventy years old. I remember the 70's and 80's. I remember how the steel industry was devastated and restructured in the 60's. I believe that the government should stop all these bailouts and let the economy falter and try to gain strength on its own. Many of are not fooled by all this tampering.

    The American public is not that gullible anymore. The average person is also tied more to the credit, financial and stock markets than it was in the depression years. We are also privy to more information than most were in those days and that makes us smarter and more aware of the future consequences and present circumstances. Only those who think they can scam the system will agree with these bills and programs. .Our whole capitalistic system is now at grave risk

    One more reason to be skeptical of all this nonsense is that government is too big and too many hands are in the cake to have meaningful reforms done honestly or implementing it the best way. Government is in the business of punishing not fixing, corrupting not helping and taking not giving back. And Democrats are in the business of taking everything they can get away from the hard working Joe who wants to just be able to make his way in life and pay his bills. Another scam in the works initiated by the U. S. Congress with special emphasis on Pelosi.

    This whole scheme is a rape of the American culture, financial system and taxpayer.

  • Report this Comment On February 20, 2009, at 4:49 PM, tfirst wrote:

    I believe the fed should be disbanded, and anyone who sat on the board shuold be tried for fraud under the RICO act!

  • Report this Comment On February 20, 2009, at 4:54 PM, GoNuke wrote:

    You can't go predicting what an intrinsic individual stock value is when you can't evaluate the systemic risk of the global financial system. All the experience, screens, advice etc. are predicated on the near absence of global financial risk. Indeed all equity valuations are meaningless in the face of massive uncertainty regarding the health of the global financial system.

    For example, the value of a piece of real estate is based on the assumption that the property will still be there next year. If tectonic plate shifts create a huge chasm into which the property falls all analyses of the property's value will have been pointless.

    Until we can estimate systemic financial risks we can't evaluate the value of enterprises or assets rooted in that financial system.

  • Report this Comment On February 21, 2009, at 12:11 AM, Damnthetorpedos wrote:

    The antigovernment ranting would be generally harmless if it wasn't for the fact that we are in this problem because of the massive fraud comitted by the financial services industry and the massive incompetance of the 9/11 administration. The concentration of economic power in the financial services industry and concentration of government power in the executive branch breeds what it always breeds and that is corruption.

    The stimulas bill is insignificant in the big picture, it is simply too small to make a major difference in any significant way.

    We have no choice but to recapitalize the banking system. It is repulsive and disgusting and the CEO's and their Bush administration croonies are the one's who should go to prison. The problem is that the thieves do not trust each other anymore for good reason --- because they all know what has been going on.

    The fact of the matter is, the world is becoming a more complex place and this will continue unless it really all just falls apart. Wishing it were not true and wishing that we could just ignor it will not make it so. It's like saying if we just close the police station and fire all the cops we would have less crime and could all make more money. Somehow I just don't have confidence that the Titans of Wall Street have the moral compass to give me confidence that my 401K $ are not being ripped off (Madoff, Stanford, how many more .....? To somehow think that if we just leave it alone and stop regulating that it will just get better is amazingly naive.

    A well regulated and generally transparent market, with distributed power, and agressive enforcement, creates the only possible playing field where we can all make reasonable returns with reasonable stability. If you enjoy the bubble and bust cycle ... well good luck with that. Regulation is like democracy, it's the worst imaginable way to run an economy, except for all of the other alternatives....

  • Report this Comment On February 22, 2009, at 5:46 PM, clevelandrudge wrote:

    I'd like to second the sentiments of Damnthetorpedos directly above. Anti-government rants would have been wholly appropriate during the Bush years---I think we have barely come to grips with the "rape of the American culture, financial system and taxpayer" that occurred on their benighted watch. I fervently hope Speaker Pelosi, who seems to be the target du jour of the looney tunes right wing, goes after Bush, Cheney and all their yes-man lackeys for the economic and social damage they have done to this country that will take years and trillions to fix.

    Judging from your post, tinybit, you've got about ten years on me. But let me tell you someting, big bro. If our precious capitalistic system is now at grave risk, it's because deregulators like Reagan opened the doors and all the Wall Street livestock ran out of the barn and they went and dumped and pissed on everything in sight, including my front yard. Big disappointment! Now it's up to the Democrats to clean up the barnyard and get the asses back in the barn. So, dude, let's be clear about who made the mess and whose job it is to clean it up.

    And guess what? The hard working Joe understands this. He and his family will benefit from the recovery that will start to take hold within a year, and he will remember who was there to help him and who was not.

  • Report this Comment On February 23, 2009, at 8:46 AM, FredBrown wrote:

    There is plenty of blame to go around for sure, but to blame Bush & Chaney shows a lack of knowledge as to the history of this mess. It started with the Carter administration creating the "Community ReInvestment Act" (CRA) for banks. This required them to make loans to minorities in the geographical areas of business. The mega banks paid lip service to this requirement but the Clinton Administration pushed the Act up the list of priorities and so the Mega-Banks had to start making what amounted to sub-prime loans. During this process they had to find a way to get them off their books as bad loans, so they started to "Bundle" them with Fannie & Freddie's blessings and sold them to the goverenment F&F corporations. The Mega-Banks found this to be a new revenue stream that produced a profit and the F&F companies grew larger also. The Clinton Administration saw what this did for the housing industry and "encouaged" the 5year car loan's so more people could buy cars. Is a 5 year car loan a good product? As I said there is plenty of blame to go around. Also Mega-Banks are not Community Banks that for the most part are sound.

  • Report this Comment On February 23, 2009, at 9:22 AM, jacoborjake wrote:

    As Jimmy Buffet sang in Margarita Ville,

    "We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful."

    Believe me, everyone is fearful!

    (Was it Jimmy Buffet that said that or Warren Buffet, arguably the greatest investor?)

  • Report this Comment On March 05, 2009, at 6:04 PM, cann211 wrote:

    John Stewart (bless his heart) recently showed a chart of the past 75 years (or whenever the stock market began) compared to historic events. Without fail, following every major positive event (end of wars, end of depression/recession, etc) the market went south. Immediately following negative events (beginning of wars, depressions, etc) the market went north! If I didn't already know not to follow the market I sure do now!

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