It's a sad but true statement: If you can count on investors (collectively) to do anything, you can count on them to get it wrong time and time again.
It would be nice to imagine that the stock market is an objective, dispassionate barometer of economic health. But on the individual level, investors are frequently irrational and emotional, making decisions that aren't in their best interests. Now is no exception.
Historically, we see the most inflows into the market 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 provides 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 Marty Whitman recently added to his position in real estate operating company Forest City Enterprises (NYSE: FCE-A ) , boosting his overall exposure to financials, which include names like Brookfield Asset Management (NYSE: BAM ) and Bank of New York Mellon (NYSE: BK ) .
Whitman is joined by Will Danoff of Fidelity Contrafund, who added to his existing holdings in Chubb (NYSE: CB ) . Fairholme manager Bruce Berkowitz has made concentrated bets on health-care picks Forest Laboratories (NYSE: FRX ) and WellCare Health Plans (NYSE: WCG ) .
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, it's a pretty good time to be thinking of getting into equities.
The fact 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.
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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!
This article was first published Feb. 13, 2009. It has been updated.
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. Fairholme is a Champion Funds recommendation. The Fool's disclosure policy's crystal ball ran off with its Magic 8-Ball.