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David Moenning is a the Chief Investment Officer at Heritage Capital, which focuses on active risk management of the U.S. stock market. Dave is also the proprietor of StateoftheMarkets.com, which provides free and subscription-based portfolio services. Dave began his investment career in 1980... More
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Daily State of the Markets
  • Are Stocks Overbought, Overvalued, Over Owned, And Over Exuberant? 0 comments
    Dec 13, 2013 8:11 AM

    Daily State of the Markets
    Friday, December 13, 2013

    One of the arguments emanating from the bear camp is that the U.S. stock market is overbought, overvalued, over owned, and over exuberant. And as you might surmise, those seeing the glass as at least half empty contend that such a combination is both (a) rare and (b) fatal to bull markets.

    Of course, it is important to keep in mind that this is the same crowd that was pounding the table twelve months ago about the uber negative macro picture which included the sequester, the Euro falling to pieces, China heading toward a hard landing, and the good 'ol USofA dipping back into recession. And for the record, how'd those calls turn out?

    Our Furry Friends May Have A Point This Time

    While the bulls have certainly enjoyed taunting their opponents in 2013, it is important to recognize that the day the reset button gets pushed is growing closer. Therefore, it might be best for players on both teams to take a step back and review the landscape with an objective eye.

    For example, those adorned in their rose-colored Ray Bans may want to take a look at some of the big picture indicators and keep in mind that all good things come to an end, eventually.

    So, this morning, let's take a look at the argument that sentiment in the stock market is entirely too optimistic at the present time.

    Are Investors Over Exuberant?

    Each week, Investors Intelligence surveys investment advisors and rates their advice as Bullish, Bearish or "Expecting a Correction." In the last four weeks, there has been an average of just 14.9% outright bears. The bottom line is this the lowest level of the four-week moving average since 1987. As such, there are fewer bearish advisors now than there were at the bubble peaks of 2000 and 2007. Yikes.

    Another way to use the data from Investors Intelligence is to look at the 10-week moving average of the percentage of bulls divided by the sum of bulls plus bears. History shows that when the 10-week average moves above 67, stock market sentiment is considered to be extremely positive. In fact, Ned Davis Research tells us that since 1970 when the 10-week average is over 69, the DJIA has returned just 0.2 percent per annum.

    An Indicator To Watch

    Taking this idea a step further, one can create a pretty darn good sell signal with this data. As we noted above, when the 10-week average is above 69, it indicates that sentiment has reached an extreme level. The trick is to then wait until the average drops below the 67-level. This is an indication that the sentiment extreme has started to reverse - and that it's time to get the heck out of the way.

    Since 1970, this little indicator has produced a total of 16 sell signals. The most recent of which came on October 9, 2013. Of the prior 15 signals, the market moved lower - oftentimes significantly so - 14 times. And in fact, this particular sell signal was flashed before the important declines seen in 1973, 1977, 1987, 2007 and 2011.

    So, with a fresh sell signal from this long-term indicator, history suggests that the bears might actually have something crow about soon.

    What About Real, Live Money Managers?

    Next up, let's take a look at what real, live money managers are doing with the money they've been entrusted with. The National Association of Active Investment Managers (NAAIM) reports each week on the equity exposure level of their member firms. While the exposure of this group will vary from week to week, from a big picture standpoint, the overall exposure tends to be low in bearish environments and high in bullish environments.

    According the originator of the survey and past NAAIM President William Hepburn, "NAAIM advisors absolutely nailed the 2008 decline by steadily reducing equity allocations beginning in late 2007." Hepburn goes on to say, "NAAIM members had an average equity exposure of only 19% from June 2008 through March 2009."

    Therefore, it is interesting to note that the NAAIM Index hit an all-time high just two weeks ago with a reading of 101.45%. This means that on average, the active managers in NAAIM were more than 100% long the stock market at that time. Granted these money managers aren't potted plants and they can adapt to a changing market environment at the drop of a hat. But the key takeaway here is that at 101.45%, there isn't a lot of money sitting on the sidelines in this group!

    Although the survey is just seven years old, Ned Davis Research notes that when the NAAIM Survey is above 73% (which occurs approximately 23% of the time), the S&P 500 has lost ground at an annualized rate of -3.8% per year. This is likely due to the fact that by the time the survey sports a high reading; most managers have already established long positions.

    So, if you aren't as nimble as the professionals in the NAAIM organization and the current level of bullish sentiment makes you a bit nervous, it might be a good time to start thinking about what your exit strategy might be if things turn ugly. Because based on some pretty good indicators, it looks like the bears could awaken from their recent five-year hibernation at some point here soon.

    Looking for a disciplined approach to managing stock market risk on a daily basis? Check Out My "Daily Decision" System. Forget the fast money and the latest, greatest option trade. What investors need is a strategy to keep them "in" the stock market during bull markets and on the sidelines (or short) during bear markets.

    Turning to This Morning...

    Good morning and a happy Friday-the-13th to all. After a string of three consecutive down days, it appears that traders have moved into wait-and-see mode in front of next week's FOMC meeting. Asian markets were mixed while European bourses are modestly higher this morning. Here at home, futures are pointing to a bounce at the open, which if the move holds would erase all of yesterday's losses.

    Pre-Game Indicators

    Here are the Pre-Market indicators we review each morning before the opening bell...

    Major Foreign Markets:
    - Japan: +0.40%
    - Hong Kong: +0.12%
    - Shanghai: -0.31%
    - London: +0.12%
    - Germany: +0.18%
    - France: +0.32%
    - Italy: +0.72%
    - Spain: +0.57%

    Crude Oil Futures: -$0.41 to $97.09

    Gold: +$3.000 to $1227.90

    Dollar: lower against the yen, higher vs. euro and pound.

    10-Year Bond Yield: Currently trading at 2.882%

    Stock Futures Ahead of Open in U.S. (relative to fair value):
    - S&P 500: +7.00
    - Dow Jones Industrial Average: +45
    - NASDAQ Composite: +15.90

    Thought For The Day...

    "You can never cross the ocean until you have the courage to lose sight of the shore." -Christopher Columbus

    Positions in stocks mentioned: none

    Follow Me on Twitter: @StateDave


    The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning's opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report and on our website is for informational purposes only. No part of the material presented in this report or on our websites is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed nor any Portfolio constitutes a solicitation to purchase or sell securities or any investment program. The opinions and forecasts expressed are those of the editors of StateoftheMarkets.com and may not actually come to pass. The opinions and viewpoints regarding the future of the markets should not be construed as recommendations of any specific security nor specific investment advice. One should always consult an investment professional before making any investment.

    Any investment decisions must in all cases be made by the reader or by his or her investment adviser. Do NOT ever purchase any security without doing sufficient research. There is no guarantee that the investment objectives outlined will actually come to pass. All opinions expressed herein are subject to change without notice. Neither the editor, employees, nor any of their affiliates shall have any liability for any loss sustained by anyone who has relied on the information provided.

    The analysis provided is based on both technical and fundamental research and is provided "as is" without warranty of any kind, either expressed or implied. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.

    The information contained in this report is provided by Ridge Publishing Co. Inc. (Ridge). One of the principals of Ridge, Mr. David Moenning, is also President and majority shareholder of Heritage Capital Management, Inc. (HCM) a Chicago-based money management firm. HCM is registered as an investment adviser. HCM also serves as a sub-advisor to other investment advisory firms. Ridge is a publisher and has not registered as an investment adviser. Neither HCM nor Ridge is registered as a broker-dealer.

    Employees and affiliates of HCM and Ridge may at times have positions in the securities referred to and may make purchases or sales of these securities while publications are in circulation. Editors will indicate whether they or HCM has a position in stocks or other securities mentioned in any publication. The disclosures will be accurate as of the time of publication and may change thereafter without notice.

    Investments in equities carry an inherent element of risk including the potential for significant loss of principal. Past performance is not an indication of future results.

    Disclosure: I am long SPY.

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