We’ve been hearing an awful lot of chatter about Bullish and
Bearish sentiment lately. It’s a subject near and dear to our hearts, being
curmudgeonly contrarians ourselves. But when it comes to Contrary Indicators of
either sentiment extreme, we continue to advise investors to exceedingly
careful with anecdotal evidence.
We’ve been hearing that “everyone is too Bearish – but the
data does not support that. Last week, the WSJ’s Justin Lahart asked “Which way is the crowd
really leaning these days?” He found that the crowd is fairly
· More U.S. fund managers think stocks are undervalued than
overvalued (Merrill Lynch).
· Hedge-fund investors’ net exposure to stocks is at the
highest level in nine months (ISI Group).
· Sentiment measures show investors feeling more bullish now
than they have all year (Ned Davis).
Furthermore, consider the sleight of hand loved on Wall Street to show how “cheap” stocks are: Wall St typically projects the upcoming 4 quarters for S&P500
earnings. At the same time, comparos are made to actual (trailing) earnings.
AQR Capital’s Clifford Asness observes this clever trick allows analysts to
tout a forward 2006 SPX earnings of $88.59 to show 14.2 P/E ratio. The same
math applied to the markets historically (1871-2003) shows a P/E ratio of 11.
With SPX 29% over its median P/E, it is hardly cheap.
“No one rings a bell
at the top,” goes the cliché. It is much more difficult to find contrary
signals at tops than at bottoms. We can look at divergences, money flows, and
anecdotal evidence – but that’s hardly as significant as all the quantitative
data generated by the panic always seen at bottoms. And, as has been noted
before, markets can remain irrational longer than most can stay solvent.
When trying to guess when markets are about to peak, what we
are actually attempting (foolish, though it may be) is the anticipation of
exactly when buyers 1) run out of cash, or B) undergo a major sentiment shift
that changes their investment views. “What is the sound made by a Bull putting
away his wallet? Hardly any.
Bottoms, on the other hand, are far easier to recognize. Our
favorite Texas expression is “Just wait for the thud the bodies make when they
hit the pavement.” For some detailed examples of those “thuds,” see our 2003
report titled Contrary Indicators 2000-2003 Bear Market.
Most investors are better off with quantitative data, and
steering clear of the ambiguous anecdotal evidence of the “He said/She said”
varieties. We’ll stick with the numbers.