That warm sense of everything going well is usually the body temperature at the center of the herd. Invariably, the majority is wildly bullish and fully invested at the top of a market and are gloomy and have a lot of cash and short positions at the bottom.
The trouble with being a contrarian these days is figuring out which way the crowd is going. I’m very bullish on U.S. and global equities, emerging markets and technology. But is everyone else as well? Sentiment is very mixed. In other words, there is no clear signal to move against.
Consider the U.S. market indicators. Each week, we track 28 of them. As of last week, 12 were neutral, 5 were oversold and 11 were overbought or near overbought. Of the five that are oversold, there are some potent measures (notably CBOE Equity Call/Put ratio, Net Futures Positioning on the NASDAQ and the New York Stock Exchange Short Interest Ratio). In the past, when these indicators were oversold, 90 percent of the time equities rose 10 percent over the next six months. Still, our composite of the indicators that have worked best is neutral. There is no pattern.
Wall Street strategists are mostly bullish, which is bad, but the Merrill Lynch fund managers survey shows a high degree of bearishness, which is good.
The hedge-fund picture is equally baffling. The ISI weekly poll of U.S. hedge funds shows that these aggressive investors are at close to record-high net long levels, meaning they are betting on stocks to rise, especially in emerging markets. This is scary because in the past, when the hedge funds in this survey reach very high long positions, markets often crack. The opposite is also true. Top hedge-fund managers may be the most overpaid, smartest investors in the world, but their record on timing the stock market is abysmal—for example, they were maximum bearish in July of last year just before markets took off. Given this, the fact that many big hedge funds are short technology right now is somewhat comforting. Geographically, it’s a mixed bag, too. In the United States, growth momentum is slowing. The collapse in new-house construction and decline in home prices are beginning to affect consumption; retail sales are sluggish. Capital spending is also weakening. The Federal Reserve will have to cut official interest rates soon.
However, the rest of the world is still chugging along. Europe—powered at long last by Germany—is growing. Japan is its usual sluggish self, but there are rays of hope, and the developing countries are accelerating. The most recent data from China have been very strong. Meanwhile inflation remains dormant worldwide—probably because of the disinflationary overhang of cheap goods and labor from China and India.
So why does acrophobia reign? Why is everyone so uneasy, having one foot out the door? Because numerous times in the last seven years, stocks have suddenly plunged—most recently only seven weeks ago. Because a lot of the so-called professionals have never run money in a grind-up bull market like this one. Because traditionally, stocks have done best when they are climbing a wall of worry, rather than a wall of complacency.
My own bullish view is supported by the fundamentals—stock valuations everywhere are reasonable, particularly compared with inflation and interest rates. Corporate profits, both in the United States and elsewhere, are still healthy, and the supply of equities is shrinking as companies buy back stock and the private-equity funds continue to feast. The amount of equities outstanding is actually shrinking almost 5 percent a year at a time when China and many other developing countries are creating huge reserve funds to buy stocks. Some of the investors I chatter with are bearish. They rant and rave about worse-case scenarios: inflation soaring, interest rates rising, the U.S. housing-market bubble bursting, and a horrible financial accident related to the derivatives overhang. But the majority are either cautious, or bullish.
That makes me nervous. Still, I remain optimistic about big capitalization, high-quality stocks in general, technology and growth stocks in particular and, above all, emerging-market equities. The first two groups are undervalued, underowned and unloved, which is reassuring. The latter have broken out to new highs, but sell at a discount to stocks in the developed world.
It’s reassuring that the crowd is “bewitched, bothered and bewildered.” I guess this makes me a contra contrarian—confused by sentiment, but still bullish.
