Saturday, October 26, 2013

The Stock Market: Up, Up and Away

Everyone knows that investor sentiment is a very reliable contrary indicator for future stock market action. As investors become more optimistic, the market becomes more risky, even dangerous. And vice versa.

When investors are more optimistic they are more fully invested. When they are more fully invested they have less cash to invest. If everyone is in stocks there are no new buyers to push the market up.

Tracking investor sentiment is an imprecise science. Many seasoned market analysts spend massive amounts of time tracking it.

Sentiment should be most easy to read at extremes. It’s like true love. Once you fall in love with stocks, and once you have invested everything in them you become wildly optimistic, to the point where you happily ignore all warning signs. The ill omens suggest that you made a mistake and you certainly do not want to hear that your euphoria is misplaced.

Yesterday’s Los Angeles Times explained the current market sentiment. By its lights the sentiment is so optimistic that we should be very wary about throwing new money into stocks. 

But, this entails forgoing what seem like easy profits… the ones your friends and neighbors are accumulating while you sit on cash that is returning 1%. (Funny thing that: the real 1% is what the Fed has allowed your money to earn these past few years.)

If the market is trying to give you money, how can you refuse?

The LA Times explains it well:

Stocks have been fueled by the belief that the Federal Reserve will maintain its economic stimulus program into next year. The shutdown appears to have boosted the market by increasing the likelihood that the Fed will extend its easy-money policies.

But the climb in share prices has been accompanied by rising complacency among individual and professional investors. That's historically been a warning sign of trouble ahead.

"Everyone is reading from same script — that you can't lose buying the dips because the Fed is by your side. And it's clearly working," said Patrick J. O'Hare, chief market analyst at

"The problem is: No one expects it not to work," O'Hare said. "Eventually that leads to higher levels of speculation that can make the setback, whenever that setback happens, more painful than it otherwise would be."

Optimism is everywhere, even among small investors who have been skeptical of stocks throughout much of the 41/2 -year-old bull market.

To a savvy investor, the phrase “optimism is everywhere” should be frightening.

Apparently, it isn't. It’s not just the rubes out there who are riding a wave of frothy sentiment. Even the professionals have gotten caught up in it.

Of course, they know that it’s dangerous, but, since they are pros, they are convinced that they will be able to see the end coming and will be able to get out of their positions in the nick of time. Remember the story about what happens when everyone rushes for the exits at the same time?

The LA Times quantifies the current sentiment:

In the latest weekly poll by the American Assn. of Individual Investors, 49.2% of people responding said they're bullish. That's up from 29% in late August. Bearish sentiment slid to 17.6% from 43%. That's the lowest since January 2012.

Professionals are even more enthusiastic. A survey last week by the financial newspaper Barron's found that 65% of money managers are bullish. A mere 8% admitted to being bearish.

Margin debt, which is the amount of money that investors have borrowed to buy stocks, topped $400 billion for the first time last month.

As the old saying goes: forewarned is forearmed.

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