You know things have gone badly wrong when the Fed floods the global financial system with $247bn to bolster liquidity. But Lynn Carpenter says contrarian investors thrive in this kind of fearful environment. Once the nervous money is shaken out of the system the calm money can roll in and buy heavily at bargain prices…

More from Lynn at Investor’s Daily Edge

Some people are contrarians because they are miserable, ornery cusses who’d walk up five flights of stairs alone rather than share “their” elevator with two strangers.

Some people are contrarians because they are pessimists and misanthropes. They think investors always go the wrong way near market bottoms and tops. If millions love it, something’s sure to be wrong with the Kool-Aid they’re drinking.

Some people are contrarians because they love a special find at a special price. We call those people value investors.

All three kinds of contrarians have reason to be in the market now. It cannot get more unstable than it has been without a circuit-breaking crash that would bring all trading to a halt—a 1929-style breakdown.

The news this week has been horrible, and that has brought a flood of cheap and cheaper stocks to the floor. With thousands of investors running for the exits, of course the pessimists and cusses are heading in.

Value investors are walking slowly. The real turnaround in the market will come over weeks as this money quietly buys in at lows.

But one thing all three kinds of contrarians agree on—fear is good for them. It’s often said that the market climbs a wall of fear. Well, now you will get to watch it happen. While the market was drifting lower, there was neither urgency nor a sense that the lowest prices were here. The values could be deeper.

I am reluctant to trust the CBOE Volatility Index (VIX) as a contrary indicator too much. But at extremes like this, it does show how markets take off. A high VIX bespeaks great fear. It is not so much that this excess of fear starts a new bull market. It is more simply that an old bear cannot reach a true bottom until it has scared everyone who can be scared. That’s when all the nervous money is out of the market, the calm money is in… and once it begins to ease prices higher as it starts buying heavily at bargain rates, the old scared money will begin to come back. Five of the last six times the VIX reached a new peak these past couple of years, it came at a low point in the S&P 500. And it preceded a rise in the index quickly afterwards.

Of course, we still have an earnings season with bad news to go… but conditions for a rally got much better when things got this bad.

Source: Fear Gives the Market Ground to Stand On