Saturday, February 11, 2012

Bullish sentiment can be bullish, not bearish

On Friday, US stocks had their worst day of 2012 as the S+P 500 fell by -0.69%. With market conditions overbought and sentiment surveys showing high levels of bullishness, does this mark an intermediate term top?

I don't think so. Let's get back to first principles on sentiment models. When investors are overly bullish, the market declines because there is no one else left to buy. Read that last sentence carefully, especially the last part. Is there anyone else left to buy?

Doug Kass thinks so, because many investors are under-invested in equities:
Today's dominant investor classes -- individual investors, hedge funds and pension funds -- have de-risked and are relatively uncommitted to equities.

A re-allocation into stocks (and out of bonds) represents an underappreciated and potentially massive (and latent) demand that could easily be the catalyst for a move to all-time highs in the S+P 500 in 2012.
Mebane Faber showed this chart of AAII asset allocation on January 27, 2012 showing individual investors were under-weight equities versus their historical average. (The figures have since been updated by AAII and individuals are only at their average weight.) These readings indicate that equity weightings have much farther to run.

Last week, Barry Ritholz spoke with one technician who said that she didn't know anyone who is bearish and even Roubini has become a bull. Ritholz then rhetorically asked, "Where are the bears?" Here is one key comment in response to his post indicating that individual investors are not excessively bullish in their portfolios [emphasis added]:
This is of interest. Helene Meisler, a technical analyst at, conducted a non-scientific survey which I’d guess probably got a majority of responses from the retail folks about how what they were expecting in the near future. Less than 1 in 5 reported they were positioned for further gains, with rest split between people expecting a pullback of less than 5% and a smaller number expecting a larger decline.

I find this interesting because the last I heard the “smart money” was slightly bearish and the “dumb money” was significantly, though not exuberantly, bullish. So either sentiment has changed, I was wrong and her responses drew from the “smart money” crowd, or else her survey sample was distorted in some way.

A series of "good overbought conditions"
The good news for the bulls is that tcombination of high bullishness and a market underweight is a recipe for a buying stampede.
Don't forget that this is a central bank liquidity fueled rally. The BoE, the Federal Reserve and the ECB (through LTRO) are committed to quantitative easing. The best analogue is the QE2 rally seen in the latter half of 2010. The market experienced a series of "good overbought conditions" as it advanced.

So am I overly concerned that stocks encountered resistance for the first time and experienced its "worst" one-day decline of 2012?

No. This is a time to be buying the dips.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.  

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