It’s long been known that a cat will always land on its feet, no matter how it falls. It’s also an indisputable principle that buttered toast always falls with the buttered side down.
Now suppose you pit these two principles against each other by strapping a piece of buttered toast to a cat’s back. Since neither the cat’s back nor the unbuttered side of the toast can land downward, the cat is permanently suspended in mid-air, oscillating around wildly as the two irresistible forces battle it out. This has been dubbed the “buttered cat paradox.” Some people believe that space-aliens use anti-gravity from buttered cats to power their space ships.
The current market situation is much like a buttered cat. On the one side, we are faced with European financial calamity. While much has been made of Slovakia's pending support for ESFS, they haven't allocated nearly enough money to fix things. Even if Greece’s borrowing costs are eliminated altogether, it can’t balance its budget. To top that off, our own country’s economy is growing slower than its population, CPI inflation has been running over 5% for the last 6 months, and the Chinese hare is turning into the Chinese tortoise.
On the other side, numerous sentiment measures indicate investors are expecting a repeat of 2008-2009, or something worse. The American Association of Individual Investors (AAII) is polling bearish sentiment at the highest levels in over a year.
In the meantime, the National Association of Active Investment Mangers (NAAIM) found that the managers they survey actually have net short positions. These managers have some money in the market, but they’ve bet even more against the market.
The AAII and NAAIM surveys are echoed in other sentiment indicators. Across the board, these indicators all suggest intense negativity — the highest it’s been since the 2008-09 meltdown. Negativity is so pervasive that you have to ask: “Who’s left to sell?” Or, even more critically: “How many people are going to have to jump back in fast if things start looking up?”
So like the buttered cat, the market is suspended in mid-air by two irresistible forces. It should plummet because the outlook is terrible. But it should soar because investors already know that the outlook is terrible--and have shorted stocks and stuffed their pockets with cash and Treasury bonds. That’s why we see the market jump 3% for days, only to fall back.
In the original buttered cat paradox, some cats contort themselves and manage to lick the butter off the toast. This works out OK for the cat, who lands on his feet. Unless he's being used to power one of the alien starships--in which case, the starship re-enters the atmosphere, and you end up with burnt toast, burnt cat, and a bunch of really ticked-off space aliens.
So what about the market? At some point, one of the irresistible forces will turn out to be very resistible and the other will prevail in a big way. If I had to bet (and I am betting), the European crisis will be the resistible force, solved by the Germans caving and agreeing to print spectacular quantities of Euros. Negative investor sentiment will prove the greater force. In fact, there are few forces in the universe greater than extreme sentiment, which we are seeing right now. The market will explode higher and under-invested active managers will be badly scorched. It will be much more exciting than a crashed alient spaceship.