The late Sir John Templeton always advised that you buy at the point of “maximum pessimism”. It sounds like great advice, but as Julian Marr points out in The Telegraph this morning, it’s actually not that helpful.

After all, if you think about it, it’s self-evident that you should buy at the point of maximum pessimism. If everyone in the market has hit the moment when they are as gloomy and depressed as can be, and they have sold as much stock as they’re ever going to sell, then things can only get better from there.

The trick isn’t knowing to buy at the point of maximum pessimism. It’s knowing when that point has arrived…

How to gauge how everyone in the market is feeling

There’s a wide range of sentiment indicators that can help investors gauge just how everyone in the market is feeling. My colleague Tim Bennett covered some of these in one of his investment strategy pieces in MoneyWeek a few weeks ago. Subscribers can read the piece here: How high are the market’s fear gauges? (If you’re not a subscriber you can get your first three issues free by clicking here: FREE TRIAL).

These indicators include things like director deals, how small investors are reacting, or how fund managers feel about the markets. These all give a veneer of science to the idea. But my favourite indicator is still the gut feeling I get from reading the papers and other commentators discussing the economy.

Here’s an example. The corollary of Sir John Templeton’s “buy at the point of maximum pessimism” idea is “sell at the point of maximum optimism.” We reached that point in the credit bubble early last year.

By that point, the credit boom was on its last legs. But it had gone on for so long that most of the bears were exhausted. None of their arguments for why it should all be going wrong seemed to be coming to fruition. At one point, Morgan Stanley’s well-known bear Stephen Roach even tentatively suggested that things might actually end up being OK.

As many people – myself included – noted at the time, that was a good contrarian signal that the end of the good times were nigh. By spring 2007 you could barely find a bearish word in the City pages. London was riding high, there was no way the stock or property markets could fall because a flood of money from sovereign wealth funds in Asia and the Gulf would keep British blue chips and prime residential properties floating on air. All the talk was of mergers and acquisitions, and the FTSE 100 hitting 7,000 before the end of the summer.

We’re not sure where the myth that rich people are not price-sensitive came from. But it wasn’t true. Bear Stearns’ hedge funds imploded, the bears rapidly regrouped, realising they’d been right after all, and down came the property and stock markets.

Have we reached the point of maximum pessimism yet?

So when will we know that we’ve reached the gloomiest point? Well, you’d expect that to be when even the most normally upbeat commentators start to say that there’s no trigger in sight to end the gloom. Just as the crash only came after most of the bears had exhausted their downside arguments, and almost everyone had turned into an optimist, so the true upturn will only come when all the bulls have exhausted their “glass half-full” arguments.

This certainly hasn’t happened yet. It takes a long time to change people’s attitudes. There are still plenty of commentators calling for an upturn by the end of the year, or suggesting that the US housing market might be bottoming out, or even suggesting that the fact we’ve not fallen into recession yet is in some way a good sign, even though GDP figures are notoriously subject to later revisions.

So although things might seem to be pretty pessimistic by the standards of the good old days (well, the past few years or so), I reckon we’re still far from Sir John’s “maximum pessimism” buying point.

I’d be looking for high-profile “Why property prices will never rise again”-type articles, or “why stocks aren’t for private investors”. I’m thinking about the point where people are thinking “it’s different this time,” only on the way down.

Read the full article

Source: ‘Maximum Pessimism’ is the Time to Buy, but Have We Reached It?