Sentiment Driving Prices Higher: Bull Is in Full Stampede Mode

Broadly speaking, three different factors drive stock prices. Firstly, the macro environment as portrayed via the economy has great influence over the direction of prices. When the economy is robust and inflation low, such growth leads to higher prices. Currently, such an economic backdrop does not exist. Although I agree that the recession is nearing completion, growth will not quickly resume. Unfortunately, I believe that our economy has been forever altered as consumer behaviors will change (i.e., more savings, less consumption) and entire sectors have been curtailed (i.e., lack of leverage means fewer jobs in prime brokerage).

Secondly, prices react to company-specific valuations. Again, this metric is not particularly supportive of stock prices. The Value Line median estimate of price-earnings (PE) ratios stands at 15.9 versus 11.1 six months ago and 10.3 when the market bottomed on March 9.

Finally, stock prices react to investor emotions. Under this metric, the bull is now in full stampede mode. One of my favorite methods of gauging investors' emotions is to examine a broad array of market indices. When price movements confirm one another, it indicates a prevailing trend. Recently, that trend has been straight up.

Over the past two days, ten of the eleven markets I follow have reached new highs. As the bulls pull everyone higher, we should expect the trend to continue and trade accordingly. Taking contrarian positions often leads to outperformance, but trading against powerful trends ensures losses. With prices continually moving to the upside, we must remain mindful of this primary trend while also managing our risk position carefully. After all, trading with the trend increases the odds of success, but recklessly chasing that trend guarantees failure.

Comments

[doubleguns:]

There is nowhere on earth one can be safe from this stampede. Lookout!!!

Aug 05 07:25 AM

[Robert A. W...:]

Nice article, right to the point. If the first and second factors are weak (economic growth and valuations relative to earnings, respectively), stocks are rising solely on the basis of the third factor (emotion, a.k.a. Kenysian Animal Spirits). As the economy matures into an extended period of de-leveraging and subdued consumerism, what will drive the future growth in revenues and earnings necessary to support the P/E expansion documented by the author? At best, stocks appear priced for average to below-average returns in a period of unusually high risk. Historically, coming off of market bottoms such as Mar-09, relative valuations were much lower (as in Aug-82). Low relative valuations, disinflation and lower marginal tax rates drove the bull market 1982-1999. None of those factors appear to be in place now, so we may just be setting up a repeat of the heartbreaking high-P/E bull-market-that-wasn't of 2003-07. As the old sergeant on Hill St. Blues used to say, "Let's be careful out there."

Aug 05 08:25 AM

[David Van K...:]

With all respect, by what definition is a 5-year, 101% increase in the S&P 500 a "bull market that wasn't"? Please be specific: How long, or by how much, does a market have to rise in order for it to be considered a bull market?

By my precepts, these labels approach meaninglessness when the 2003-2007 market expansion of 100%+ is dismissed like that. In what way was it heartbreaking? It was certainly investable. It lasted long enough for even the most inattentive investor to participate in at least part of it. Anybody using simple sell stops got out of it with most of their profits intact when it turned down in October 2007. Does it have to be "secular" to achieve bull-market status? Does it have to last 10+, or 14, or 16 years, or "a generation"? I'd really like to know.

Aug 05 08:39 AM

[Robert A. W...:]

Hi David: I think that's an excellent question. Honestly, I hadn't thought of a specific answer until you prompted me to do so. Technically, there is no widely-accepted way to measure the legitimacy of a bull market. To jump-start the dialogue, I would propose that a bull market is legitimate when buy-and-hold investors earn real stock returns that exceed the real return on bonds. The Mar-09 low of approximately Dow 6,500 took us back to 1996 levels (nominally), indicating a tremendous loss of real wealth for equity investors. When investors are better off in bonds for more than a decade, I'd say that's a "faux" bull. Rob Arnott's paper in the Journal of Indexes discusses this in depth; it's a great read (the link is long, hopefully it will reproduce): www.indexuniverse.com/....

On Aug 05 08:39 AM David Van Knapp wrote:

With all respect, by what definition is a 5-year, 101% increase in
the SandP 500 a "bull market that wasn't"? Please be specific: How long, or by how much, does a market have to rise in order for it to be considered a bull market? Does it have to last 10+, or 14, or 16 years, or "a generation"? I'd really like to know.

Aug 05 09:00 AM

[enigmaman:]

The more institutional money managers that step back into the market the more positive their remarks about the future they will have, When they were out they doubt, now that they are in they spin. Recent reports of estimated 18% Gov tax revenue loss was big news, or was it, nobody seemed to pay it any mind. Today company layoffs appear to be back in favor almost 100K projected and to continue each month, Whats the old saying about "Catching a falling knife?" seems to me the remarks about economy is still falling but slower, doesn't mean much until it hits the bottom and picks itself off the floor. Maybe the worst isnt over, maybe its yet to come. The more institutions that scream " all is well" the more concerned I get.

Aug 05 09:42 AM

[Obi-Wan:]

Can someone explain the competing factors of 'high investor emotion' and 'light trading volumes'.....???

Confidence doesn't appear to be there totally, but yet the market continues to ignore the 'less bad' news....

Did the market overcorrect after Lehman.....or are we overcorrecting now....???

Hang on!

Aug 05 10:04 AM

[enigmaman:]

I read somewhere that there were 2B+ in equuity purchases but only 400M is redemptions from Money market accounts which makes you wonder where the investor money is coming from, little detail but plenty of hype behind this rally.

Now some are saying the lower trading volume is the new normal, starting from a new base line, some say its all electronic and then some say I dont care the trend is your friend.

Ignoring the less bad news, kind of like
the bad news- your dieing,
the less bad news- your dieing at a slower rate,
the long term prognosis- hope for the best (invest) expect the worst ( tight stop loss)

Did the market over react or did we ovecorrect- that depends on how you make out.

Now that more pros are investing they need to justify and convince the bench warmers they are missing the boat, not if its the Titanic

When they say come on in the waters fine, I want to know what do they mean by FINE!

On Aug 05 10:04 AM Obi-Wan wrote:

> Can someone explain the competing factors of 'high investor emotion'
> and 'light trading volumes'.....???
>
> Confidence doesn't appear to be there totally, but yet the market
> continues to ignore the 'less bad' news....
>
> Did the market overcorrect after Lehman.....or are we overcorrecting
> now....???
>
> Hang on!

Aug 05 10:19 AM

[Mad Hedge F...:]

Get out of the way. Welcome to the new bubble. In four months we have gone from 35% below the 200 day moving average to 15% above. It turns out that 1,000 in the S&P 500 is 38.2% recovery of the fall from the 2007 peak, a great Fibonacci number. DeMark indicators are showing that buying power is getting exhausted. Daily sentiment indicators are 88% bullish. RSI’s and oscillators are over extended. Every day the buyers show up, marching in lockstep with military precision, to give us our needed spike up at the close to keep the rally alive on the charts one more day. Worst of all, I am getting deluged with emails from subscribers who, having stayed out all year, are asking if they should start buying now, and buying everything. All of this, and we still have the second half of the “W” to discount. If the American stock market was the only issue, I wouldn’t really care, since most of my longs are overseas. But if the US rolls over like the Bismarck, emerging markets, foreign currencies, commodities, the energies, and junk bonds will be dragged down with it, because everything is so interlinked these days. There will be no place to hide. I think the glass half full crowd is coming to the end of their run, so I would urge investors to pare down some risk. If your friends stay in, and they make a ton of money, that’s fine. Just let them buy the next round of drinks.

Aug 05 11:08 AM

[j-dub:]

Back by popular demand


WALL STREET'S NEW REALITY


GM chapter 11 = PRICED IN
125K+ jobs lost from GM chapter 11 = PRICED IN
unemployment @ 9% = BETTER THAN EXPECTED
unemployment @ 10% = DOW SOARS
unemployment @ 11% = GREEN SHOOT RALLY
unemployment @ 12% = ALREADY FACTORED IN
unemployment = 35% = DOW DROPS 100 POINTS
housing price = -1% = RECESSION ENDING
housing collapses = GREEN SHOOT
Housing falls 20% = STABILIZATION
Government spends 1 trillion of OUR dollars = STIMULUS
North Korea fires nuke = RALLY
Israel bombs Iran = 30 MINUTE END OF DAY RALLY
world explodes = ASIA RALLIES
PMI crashes = HUGE RALLY
No jobs are created = RECESSION ALMOST OVER
U.S. debt overwhelming = TOO BUSY RALLYING TO CARE
Consumer stops spending = RETAIL RALLY
Banks are insolvent = SIGNS OF STABILIZATION
American auto industry BK = GOOD THING
Banks pass scam stress tests = HUUUUUUUUGE RALLY
Banks "only" need 75 billion = OUT OF THE WOODS
Banks pass a real stress test = NEVER WOULD HAPPEN
Banks pay back tarp = LATE DAY SURGE
Banksw can't pay back TARP = EARLY MORNING SURGE
12% mortgage delinquency = GOOD FOR STOCKS
Hundreds of thousands of mortgages underwater = HOUSING BOTTOMED
Dollar rises = RALLY
Dollar crashes = RALLY
Inflation = BULL MARKET
Deflation = BULL MARKET CONTINUES
REFLATION = MASSIVE SHORT COVERING RALLY
Gold rises = STOCKS RALLY
Gold falls STOCKS RALLY BIG
Banks' fake earnings = SIGNS OF STABILIZATION
CRE stablizing= 1000 POINT RALLY
CRE CRASHING = STOCKS SHAKE IT OFF TO RALLY
CONSUMER INSOVENT = CONSUMER IS SPENDING
OIL @ 50 = BULL RALLY
OIL @ 60 = GREEN SHOOT
OIL @ 100 = IMPORTANT RECOVERY SIGN
OIL @ 20 = TAX BREAK

And the one we should all interpret corrcectly:
NO ONE IS BUYING STOCKS = BILLIONS ON THE SIDELINES

Aug 05 02:36 PM

[Benito Camela:]

Please note the BoE's move today. It seems that another large institution might be into trouble in the UK.

Equities are expensive unless you buy the make-believe accounting used specially in banks. Just focus on honest cash flow and you get a different picture.

Aug 06 08:29 AM