Got You Covered

IT’S THAT TIME OF year again—when magazine editors put on their Nostradamus hats to offer up get-rich-quick schemes for the new year. “What China’s Best Investor is Buying Now,” reads the cover of Fortune, along with “40 Stocks for the New Decade.” The magazine even praises perennially unpopular Goldman Sachs. “Not your father’s vampire squid,” Fortune says.

These kinds of headlines seem comical, but it turns out they may be good for more than just entertainment. A few years back, two analysts at Citigroup developed what they dubbed the “magazine cover indicator.” The premise, they said, is that when a magazine “finally devotes a cover to a market trend, company, country or person, the story… has been in vogue for some time and is likely past its peak.” In other words, the magazine cover indicator is a contrary indicator. By the time an investment appears on the cover of a magazine, it may be time to sell, not buy.

How did Citi’s analysts reach this conclusion? They went back to 1998 and collected each of The Economist’s weekly covers—nearly a thousand in all. Then they looked for headlines that included an “emotional or hyperbolic portrayal” of an investment. Their findings: In nearly 70% of cases, the covers were wrong within one year.

And, of course, it isn’t limited to The Economist. Its prognosticators are no worse than other publications’. In fact, one of the most famously incorrect headlines appeared on the cover of Businessweek, now Bloomberg Businessweek. In summer 1979, the magazine declared “The Death of Equities.” Almost immediately, the stock market took off. Over the subsequent 20 years, the S&P 500 rose more than 13-fold.

Citi’s analysts aren’t the only ones to make this observation. Economist Paul Krugman once wrote, “Whom the Gods would destroy, they first put on the cover of Businessweek.”

Does this mean you should drop everything and start trading based on magazine covers? As you might guess, I don’t see this as a workable strategy—for two reasons.

First, while amusing, I would take this research with a grain of salt. I think it’s more right than wrong, but I’m not sure how scientifically rigorous it is. In fact, The Economist, in its own defense, argues that headlines are subject to interpretation, making it difficult to grade them on a strictly quantitative basis. Complicating matters, The Economist points out—correctly—that there is a disconnect between economic performance and stock market performance. They don’t move in lockstep. To use its example, a headline reading “UK RIP?” shouldn’t be narrowly interpreted as a recommendation against British stocks. It’s difficult to know how the analysts at Citi scored potentially ambiguous headlines like this.

The second reason I’d be skeptical is that sometimes magazine commentators are right. A notable example: In August 2007, Jim Cramer, writing in New York magazine, issued a clear warning about the housing market. By then, only a few cracks had become visible. It was a full year before the bottom really fell out, so Cramer was definitely out in front with his warning. I call this example notable because Cramer is routinely ridiculed for his over-the-top style and mixed track record. But in this case, he was absolutely right.

This illustrates why I see the magazine cover strategy as unusable. If the buttoned-up folks at The Economist can be so wrong on occasion and the wild-eyed likes of Jim Cramer can be so right, it’s hard to know who to trust and when. This is not the foundation for a reliable trading system.

Don’t get me wrong: I think Kiplinger’s, Money and their peers offer a wealth of valuable information. If you’re looking for advice on managing debt, buying a car, paying for college or any number of other important questions, they’re a great resource. Just be sure to avert your eyes when they—or anyone else—reaches for their crystal ball.

Adam M. Grossman’s previous articles include An Unkind Act, The REIT Stuff and Candy Land. Adam is the founder of Mayport Wealth Management, a fixed-fee financial planning firm in Boston. He’s an advocate of evidence-based investing and is on a mission to lower the cost of investment advice for consumers. Follow Adam on Twitter @AdamMGrossman.

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