Too Much Bearishness

Summary

• Markets continue moving gradually higher.
• News flow quiet as we proceed through the summer months.
• Despite that, investors are getting worried about a market plunge.
• This fear is likely misplaced.

I've just gotten home after a month in Colombia with my family. As far as markets go, it appears I didn't miss much. The S&P 500 (NYSEARCA:SPY) traded in a mere 2% range for the entire month. Barring a short-lived sell-off in tech stocks, pretty much nothing notable occurred. Summer trading is known for being slow, and 2017 isn't shaping up to be an exception.

^SPX data by YCharts

As I've often said in this column, stocks don't tend to nosedive out of the blue. A market that is making new highs generally continues moving upward gradually until something major comes along to disrupt the trajectory. The trend is your friend became a popular trading adage for a reason.

It generally takes a month or more of choppy prices after a new market high before a real correction can get going. So, when you see new record levels (the Dow Jones hit one Thursday, and the S&P is only a few points away), you should put away bearish thinking for at least a few weeks.

And yet, steadily rising prices tend to bring out the skeptics and top-callers. Despite it being the center of the summer lull and there being nothing of note going on with corporate earnings or geopolitics to rock the boat, numerous people seem to think the market is in a dangerous zone here. Consider the top of Seeking Alpha's website Thursday, as the market was surging higher once again:

I don't have any comments on the specific articles I highlighted - I just reference them to show the general mood. Seeking Alpha's trending articles are in large part determined by how many readers are clicking on something at any given time. Thus, out of all the articles on the site, investors are gravitating toward heavily-bearish slanted ones as the market rallies in a quiet trading period.

Barring some sort of black swan, the odds of the US market crashing over the next month are virtually nil. In quiet trending bull markets, there is little reason to fret about sudden market plunges; it is largely a waste of time and can be detrimental to your investing results if it causes you to sell out of stocks too soon or start betting on the short side.

Let's look at some historical market tops - you'll see the punishing declines never come right after the market peak. 1987 - market peaks in August, trades flat to back up into September, doesn't crash until late October:

^SPX data by YCharts

2000: While tech stocks rolled over pretty quickly, the market as a whole topped in March and proceeded to trade sideways all the way until September before really starting to dive. You had numerous good selling opportunities well after the market peaked in March.

^SPX data by YCharts

2007-08: The market "flash crashed" in February, causing me to dump almost all my stocks thinking the market had (finally) peaked. Ultimately, despite the housing market already being in full-on collapse, the market wouldn't top until October of that year, and you had good chances to sell until January of 2008 - as late as April 2008, the market was only down 10% from peak levels. Even when the biggest financial wreck since the 1930s was clearly on the way, the market took ages to roll over:

^SPX data by YCharts

Don't Worry Too Much About Market Timing

At some point, the current bull market will end, and we'll get a sharp downturn in stocks. That's an inevitable fact. However, many investors risk hurting their returns by sitting in cash for far too long.

Consider January of 2016. I wrote at the time: The Bottom Is In - Now What? when the market hit 1,812 and then reversed sharply.

^SPX data by YCharts

The market would retest the low in February, but from that point on, the market has been almost straight-up. Look back now, and you'll see that article had over 200 comments, many of which suggesting that the market was about to crash and burn as stocks were still too expensive.

Presumably, these folks that thought the market was overpriced at 1,800 certainly think it is silly expensive at 2,450. And, they may be right. I've been saying for years that the US market is overvalued on an earnings basis - but that doesn't stop me from investing entirely. The opportunity cost of not owning stocks is high, call it 6%/year annualized (return of stocks minus return of cash).

To give a tangible example, the market would now have to drop 25% just to get back to where we were last January. And, over that time, the market has also paid a dividend yield in excess of the return on risk-free cash as well. Bears will eventually be right, but even a 20% decline hardly rewards someone who has been sitting in cash for years now. It'd take a major economic problem to break the January 2016 lows, and people dreaming of seeing 2012 prices again are likely to be disappointed.

None of this is to say we should be complacent. But the crash-callers are likely to be early again - and being early costs most people a lot of money. Retail investors are quite negative on the market's outlook:

Put it all together, and you've got overly skittish investors amidst a steady continuation of the bull market during quiet summer trading. The market is likely to continue higher, or at worst go sideways, for at least the next few weeks. Don't get yourself all preoccupied with crash warnings - or worse yet - spend heavily on hedges or downside bets such as volatility.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[mykie]

Nice article, Ian, and as usual right on the pulse of things as indicated by all the comments.

[JOE STERN]

It might be healthy to remember some history. People bought stocks of new internet companies that had no earnings and bid up their prices into the stratosphere. Greenspan warned of "irrational exuberance" and the market paniced for a few days. Those who had missed the rally saw their opportunity and bought the dip and the market partied on. A year later, Greenspan warned of "unfounded euphoria" and hardly anybody paid attention. People who had never owned stock before were buying and making money. If tech companies were worth hundreds of times earnings, if they had any earnings at all, then certainly solid industrial companies and retailers were worth 30 or 40 times earnings. Then the internet stocks crashed and the market took that as an "all clear" sign, it's safe to invest now, and the party continued a few months more until the bears finally took over. I'm not saying we will see that much recklessness leading up to the next top, but I hardly see any now. Everyone has one eye on the exit door, and that is a healthy attitude to have.

[alpha_guy]

Everyone has an eye on the exit door because everyone knows current prices are artificial and wholly dependent on central bank intervention in asset "markets" (I use the term loosely). Who could be comfortable in that situation? That's why there can be no euphoria despite these outlandish prices.

Everyone's a speculator now - there's very little investing going on these days.

[User 48013832]

Ian, enjoy busting your chops over Hormel but this is valuable article that gives perspective without bias.

Good work.

[Ian Bezek]

Soon you'll come around to HRL. Regardless, appreciate your feedback.

[User 48013832]

It could happen but the charts and sentiment are in Hormel's favor right now. Hope that changes soon.

[Michael Bryant]

If you really want a hedge, just buy a good dividend stock, preferably a dividend growth stock. OKE yielded 10% several months ago. RDS.A yields 7%. BP yields 6.8%. CVX yields 4.1%. SLF and NRZ yield 13%.

Or buy gold. GLD has nearly matched the S&P 500 YTD. Or combine the two with a dividend gold stock. ABX could do.

[snoopy the economist]

Buy GLD? 'Paper gold' is worthless.

[ThinkAheadWins]

Will we have a stock market crash at some point? Yes we will. By "saving us", all the FED and other central banks did is make sure the next crisis is even bigger than the last. Despite the doom in that statement, I don't see a catalyst for a bear case in the near term (6 - 12 months). The reason being that the world is currently awash in liquidity. It's easy to see that based on asset prices, art prices and even how much real estate the Chinese have been buying up around the world. As another example, the Swiss national bank (SNB) has been busy printing money to keep their strong currency in check. What have they been doing with the money they are printing you ask? They are buying dollars and euros and purchasing US and European equities. Switzerland is now the eighth-largest public holder of US stocks.

The big unknown right now is the FED raising rates and unwinding its balance sheet. I would keep a very close eye on how that unfolds (I don't believe the FED really understand how to go about doing this). To be honest, I am extremely concerned about the herd mentality the central banks have adopted. When governments and banks flood the market with so much liquidity all in a coordinated effort, it is wise to pay attention. In the long run, the big question is, have all the liquidity injections saved us or simply turned the whole financial market into a Ponzi scheme?

[clrodrick]

I came across another interesting tidbit from the 'bear' camp side.

Never in history has an hour's worth of labor (forget if it was median or average) bought a smaller piece of S&P 500 than today. Food for thought. Might be more an indicator of globalism leaving behind 80% of the population in terms of wage gains keeping up with inflation more than anything else.

[AuCoaster]

Meaningless garbage. It just reflects the fact that the economy gets bigger, while one hour of labor is still one hour of labor. So, the ratio should keep shifting. Never before in history has one hour of labor been such a small percentage of the US GDP.

[Eric Peterson]

"Never in history has an hour's worth of labor bought a smaller piece of S&P 500 than today."

That just means the SP500 has gone up more than inflation. An expected result, nothing surprising at all.

[clrodrick]

okay, well it might be meaningless garbage to you which is fine, but tell that to the working 80% out there who keep seeing their wages not keep up with inflation and try to save for retirement but find their wage in 2017 has hit a new historical low in terms of bang for the buck in buying S&P. That was the main point. I for one am quite thankful I got the chance to take advantage of two great blow ups (2000 and 2008) to really put cash to work and buy at fabulous lows. No such luck for folks now with markets on central bank auto pilot

[mikeca]

Our GDP will be larger ten years from now. Also the S & P will be higher. No rocket science necessary for this prediction.

[tyler94]

Right! Most folks worry over short term noise while ignoring the long term good news.

[Logan Chierotti]

Well written article Ian, I couldn't agree more

[John Naccarelli]

a bear in perpetuity will be right just as a broken clock is correct twice a day.

[Franklin123]

Equity is still cheap and the IWM has not had a 4% down week (rolling) since Feb 4th and two weeks after that it printed the first of two epic buy signals - not having looked back since. Is it closer to a top than to a bottom - maybe - but that depends on time frame and we won't know the answer to that until after it happens. In the present - it is printing a buy.

And....by the way, I do have the crash signal code that has avoided 2 out of three "crashes" defined as one week draw downs in excess of 20%. Engineered "flash crashes" that amount to stop running raids are not predictable - that's the whole idea.

[Fabien Hug]

There is also an important distinction to be made that is rarely mentioned; crash or bear market. The financial effect is the same but the layout is completely different. In my view, there is nothing you can do against a crash. In the exemple shown, the slight downward slope before the 1987 crash was certainly considered a healthy correction and a pick the bargain opportunity.
In a bear market a simple MACD cross signal on a monthly chart should protect you well without too much flip flopping.

[LTTFTrader]

Fabien,

Ned Davis published a very simple trend-following algorithm in the early 1980s. It works as follows: Keep track of the weekly closes of a small-cap index. Buy when there is a 4% or greater rise; sell when there is a 4% or greater drop.

Here is how this worked in 1987 using Russell 2000:

Date **** R2k close
=============
19870821 174.30 <== 1987 high value
19870828 173.17
19870904 170.52
19870911 170.54
19870918 168.75
19870925 168.85
19871002 172.08
19871009 166.12 <== 4.7% drop from 8/21. Sell.
19871016 152.74
19871023 121.59
19871030 118.26
19871106 119.33
19871113 118.31
19871120 114.45
19871127 115.61
19871204 106.50 <== Low point
19871211 109.32
19871218 119.46 <== 12.2% rise from 12/04. Buy. Gain = 28.1%

This still works, although 4% is not always the optimal threshold.

[Jonathan Whipple]

Tech stocks are moving far above their 50 SMA which many consider to be a level of support/ resistance depending on the scenario. Although I see you're argument that there is a lot of bearish sentiment in today's market, we still can't over look the concept that much of today's stock has risen at an unprecedented rate causing many to not invest given the idea that it is now overpriced.

[tsac51]

Tech is again moving up because of earnings over the next few weeks which last quarter were great. There may be a selloff if earnings disappoint.

[clrodrick]

I will continue being relatively long biased as long as global QE keeps up it's pace of > 200 billion per month (currently at 300 billion). Several analyst reports I've read come to the conclusion that 200 billion per month is currently needed to keep global markets from crashing. They seem to be right, so I'll take their word on that. But if ECB stops just jawboning and actually does start to meaningfully pare back on pace of QE, I will be scrambling to the sidelines.

In the meanwhile, it is snoozeville this summer. Pared back a good deal of risk in selling any and all of my levered funds as well as any junky high yield funds/stocks. Also sold off my generic ETFs and am replacing them with what I hope to be some carefully selected individual companies that have good balance sheets and can weather any storm.

I also bought T/VZ to replace my junk bonds with. Similar yields but IMO they are much more stable if/when junk crashes again.

[stephenmcmahon83]

Some people commenting above have implied that "money has to go somewhere and it is unlikely to go to bonds at current rates, even if there is a correction in stocks."

These people don't seem to understand that if investors suddenly get scared and decide to sell Amazon stock when it is $1000 per share and buyers are only willing to pay $950 per share, if they hit those bids and sell at $950, that digital $50 difference just disappears into thin air as if it never existed. Good-bye, gone forever....that money doesn't just "trickle into bonds", nor do "short sellers automatically make a profit from the decline in price."

This idea that "money has to go somewhere" is a fundamentally flawed premise. In the event of mass selling, the money literally disappears into thin air like it never existed; it does not flow from one brokerage account to the next.

[17072452]

stephenmcmahon83, what about the guy on the other end of that $950 trade? I'm certain that if he shorted earlier at $1,100 and then bought your shares back at $950, his account pocketed net $150. So yes; SOMEONE's (not necessarily yours) capital or capital gain gain must flow into somewhere else. It's called wealth transfer...and it happens under any condition! The real question becomes -- once those transactions occur, what asset classes will be next?

[GR Value]

A lot of stocks are getting into bubble territory. MSFT has $9 book value and is trading at 32x EPS or more than double fair value historically.

Yes, stocks may gradually go higher, why not, but nothing is cheap. And you'd be better off avoiding indexed stocks than entering here imo.

[chrisA23]

Regarding an earlier comment on TA, the real scientific studies show it does not work in the long run. Here is the abstract of a big study, not the opinion of a lucky analyst.

Technical Analysis Around the World:
Does it Ever Add Value?
Ben R. Marshall*, Rochester H. Cahan, Jared M. Cahan
Massey University
New Zealand
Abstract
Technical analysis is not consistently profitable in the 49 countries that comprise the Morgan
Stanley Capital Index once data snooping bias is accounted for. There is some evidence that
technical trading rules perform better in emerging markets than developed markets, which is
consistent with the finding of previous studies that these markets are less efficient, but this
result is not strong. While we cannot rule out the possibility that technical analysis
compliments other market timing techniques or that trading rules we do not test are profitable,
we do show that over 5,000 trading rules do not add value beyond what may be expected by
chance when used in isolation.

You can look up the details of the study on the net, it is published by people who do not make money selling a TA program, they are researchers.
However, I do look at charts after I make fundamental decisions to buy or sell and the chart might affect how many shares I do buy or sell or the price point, but really it is the fundamentals that matter most. Even then the main thing I notice is that over the last 100 years markets tend to go up so I do not short, there is enough to do long and the river is flowing in the right direction mostly.

[tsac51]

What fundamentals do you look at?

[LTTFTrader]

Chris, This study is truly right on the money. Technical indicators have been known about for decades, but no one has ever figured out a good method that uses them alone. But pure momentum investing does work. One of the greatest fundamentalists of all time, Benjamin Graham, pointed this out a long time ago.

[chrisA23]

I recently checked the last 35 years and glanced at previous decade and found that every market top in 35 years has been when the 10 year treasury interest rate is higher than the stock yield. We have 21 P/E GAAP on DJIA and 24 GAAP on S&P500. 24 is a bit over 4% profit.
So we are not even near what those other tops had because people could go buy a treasury bond and get in most cases close to 6%.
So as the author mentioned, it normally took an unusual big event to bring down the market (earnings grew for a couple years after the 87 crash. I was a broker then and remember we somehow thought a bull had a time frame as much as it had a conditions frame.

Anyway we have 2.3% on the 10 year vs 4+ % on the S&P500 (better if you use GAAP cause inflated operating earnings are not what they have to send to the govt.). That means this is not an expensive market, especially with slow but growing GDP worldwide and low inflation.
I'm long DJIA and some other things.

[18214212]

Chris, 35 years is a long time, but how many market tops existed in those 35 years ? ( I mean generational market tops like in 2000 and 2007, not the simple ones which correct in an ongoing bull ). Seems to me we had an 18 year bull from 1982-2000, so were the only 2 market tops in the last 35 years in 2000 and 2007 ? Doesn't sound like too many samples ( although the basis of your thesis is sound ).

[User 1014498]

Well said. The 10-year may be at 2.4% by the end of the year.

See https://goo.gl/Xi19SK

It's hard to predict.

See https://goo.gl/cpLAZZ

[sj12]

Chris - QE inverted that dynamic with central banks buying stocks and bonds so that's not a good indicator to use anymore.

[LuvMyBonds]

The S&P is going to collapse- BIGLEY! A fool and his money are soon parted. If you want to believe the permabull hogwash that the S&P will rise forever and never turn back then you go right ahead and bet it all! Bet the whole farm and watch what happens!

[tyler94]

Someday you will undoubtedly be correct but no one knows when.

[Marcus Cicero]

A problem with the "too much bearishness" argument is the fact that some people (such as myself) describe themselves as bearish while remaining fully or nearly fully invested in the market. Moreover, a corollary of the "too much bearishness argument" is that bears will have to allocate capital to the market before a top can be reached. However, this correlate is also problematic because bearish investors who are fully or almost fully invested cannot move more capital into stocks.

[Spend_time_in_the_market]

You are not the rule but an exception. The vast majority of bear do not allocate near 100 %.

GLTA

[larrhall]

Disclaimer - I am a novice investor that only recently had a substantial amount of money in the market.

I do not believe there is a lot of bearish sentiment. At least, most market commentators at CNBC and elsewhere are pretty bullish. I do believe that the real-world translation of your use of the term 'bearish sentiment' is 'many wealthy people/funds are cautious and will yet put money in the market as it refuses to collapse.'

This is what I think is happening. I try to pay attention to different commentators. So, for example, Santoli and Santelli at CNBC come off as very fact/analytic based as opposed to some of the traders you get at Fast Money. While the Najarian brothers and others might know a great deal about an individual stock's situation, they are not really speaking to long-term investors. But that is the issue - how many of us that should be long-term (or at least medium-term investors) think that way, and how many of us jump around and start to panic as if Najarian were a better source than Santoli? I have my answer, which is also a self-criticism.

[tsac51]

There are a lot of bearish commentators on cnbc. I also watch fast money. Since the Narjarian brothers are short term option traders, they're not looking at the long term in the market. You really don't know what they think about stocks one or more years out. They were quite wrong on what the action on the banks were going to be on earnings. To me it was obvious, there would be a short term selloff. With low volatility, trading desks didn't make much and for some reason, a lot of traders view of the banks was that with fast rising rates (LOL), the banks would be more profitable. The fed is not going to raise rates much for a long time.