Since this rally began over the summer, there has been an ongoing debate about whether there has been sentiment extremes. I have argued that the VIX, the put call ratio, the lack of 1 or 2% down days, and the reckless abandon which people have been buying equities has been signs of bullish sentiment. It had gotten frothy, but not quite excessive yet.
Others have said the "disbelief in this rally" proves the lack of excessive bullish sentiment. Dresdner Kleinwort's James Montier notes that the rally has been driven by the "Fully Invested Bears and rampant complacency" -- that hardly sounds like bearish sentiment is dominating the discussion.
Although I always aim to use quantifiable data, rather than gut feel. The one exception has been the "propped up feel" to the market pre-Election: It started with the changes in the Goldman Sachs Commodity Index, which led to the huge energy complex sell off. Either Goldman's commodity group is run by a bunch of clueless dolts and naives -- or this was a purposeful attmept to influence the US mid-term elections.
The second "gut issue" has been the midnight Futures buyers -- gobs of SPX futures bought 25 handles above closing prices smells like manipulation -- at least, thats the verdict by several people with far more Wall Street experience than I.
Since I am not a conspiracy fan by nature, let's get back to quantifiable data, rather than gut feel. One measure that ha sbeen track fro a long time is the general "Bullishness" of newsletter writers. According to Hulbert, investment newsletter editors are about as bullish as they have been in nearly five years — and that doesn’t bode well for the stock market:
"When investors are wildly optimistic, head for the hills; when they are truly pessimistic, buy stocks. That, at least, is the counsel of contrarian analysis, which derives its name from the idea that the market, in the near term, rarely does what the majority expects it to do.
When pessimism and despair reach extreme levels, for example, contrarians believe that the market is at or near a bottom. That’s because any short-term traders who are likely to sell their stocks when conditions are unfavorable will have already dumped them — removing potential selling pressure that could drive the market still lower. The reverse is the case, the contrarians say, when optimism is extremely high.
Consider the sentiment that prevailed when the stock market hit a low in June this year. According to The Hulbert Financial Digest, investment newsletters that focused on timing the stock market’s short-term trend recommended, on average, that their subscribers allocate 88 percent of their equity portfolios to cash and the remainder to shorting the stock market — an aggressive bet that stocks would fall further. Far from declining, of course, the Dow Jones industrial average is now almost 1,500 points higher."
That's the theory underlying contrarian sentiment analysis.
"By Nov. 24, by contrast, the average recommendation of this same group of newsletters had changed greatly — to allocating nothing to the short side of the market and 71 percent to the long side. Though the newsletters cut their average recommended exposure by 12 percentage points on Thursday, to 59 percent on the long side, the level is still very high — double the average since the bull market began in October 2002."
Bottom line: At least by this one single measure, sentiment has reached a pretty aggressive level -- not off the charts extreme, but certainly noteworthy.
As we noted last week, a modest short is in order in case last week's market cracks expand. My gut says the Golidlocks crowd might have one last year end spurt in them.
I continue to marvel over the chasm between what is happening on trading desks/in the market, and the economic realities on the ground. Eventually, this "disconnect" will get resolved -- either by the economy turning upwards, or the market turning downwards.
Meanwhile, we will continue to monitor our individual indicators and sector analysis.