Fearing Greed

I.C. Angles Investment Post…

Investors should be nervous about the stock market, but they’re not, and that’s even more reason to be worried. Retail investors tend to sell low and buy high, and throughout the current bull market they have been mostly negative on stocks and missed out on much of the gains. Now after years of strong returns they’re finally turning positive on stocks. That is not unusual. Investors react to performance. At stock market bottoms prolonged market losses make them fearful, and at market tops years of gains make them greedy for more at just the wrong time. Some measures show investor sentiment has not been this positive since the last stock market top, and if history is repeating retail investors are turning optimistic on the stock market just in time for the next bear market.

Dumb Money Bullish on Stocks, Smart Worried

Multiple surveys show growing investor optimism for stocks. The AAII Investor Sentiment Survey showed in late July bullish investors outnumbered bearish ones by a two-to-one margin. The John Hancock Investor sentiment index continued its rise with 62 percent of investors saying in the second quarter of 2013 that now is a good time to buy stocks. Similarly, a survey from the Institute of Private Investors showed that a majority of families worth $30 million or more are focusing on growth, rather than capital preservation, with 42 percent planning on decreasing cash allocations. The Goldman Sachs Rotation Index reached its highest point since late 2008, as retail mutual fund flows showed a bias for taking on risk and owning more stocks. On a similar note consumer confidence jumped to its highest level since 2008.

But not all investors have become more bullish. June data shows institutional investors, the so-called smart money, net sellers of stocks, while the dumb money, retail investors have been net buyers. TD Ameritrade reported that data compiled from its retail accounts, showed such investors getting more bullish throughout June. The smart money is likely paying attention to China’s economic troubles, Europe’s continuing difficulties, weakness in emerging markets and signs that central banks may scale back accommodative monetary policies.

Some of those selling stocks may also be getting spooked by some ominous chart patterns. The bull market topping in 2007 and the current bull market if currently cresting appear as if mirror images of one another, with margin debt at correspondingly high levels. The long term market topping and bottoming pattern since 2000, also resembles the last secular bear market in the ninety seventies, just before that stock market rolled over to make a new low in the middle of that decade. And on a short term basis current market action with marginally higher highs being made, amidst volatility, also resembles the previous two market tops.

Is Sentiment Extreme Enough?

One of my favorite investment truisms is Warren Buffett oft repeated advice to, “Be fearful when others are greedy and greedy when others are fearful.” But are retail investors greedy enough to warrant fear? That today’s levels correspond to the last market top is an argument that they are indeed greedy enough to elicit fear in contrarian investors who fade sentiment. But today’s stock market greed is a far cry from 2000 and other market tops reached in the last secular bull market. A lot of retail investors have sold bonds recently and instead of buying stocks are presently holding cash after being so badly burned over the past several years in the stock market. Therefore an important question is whether more modestly positive sentiment levels at the last stock market top were an anomaly or indicative of sentiment tops in the midst of a secular bear market. I would argue the latter and if so investor sentiment may be as positive as it will get before a bear market begins.

Common sense would suggest that the current secular bear market is turning the long-term bias of investors increasingly negative on stocks. To crush a generation of investors’ hopes and dreams for stocks doesn’t transpire over the course of a single bear market. Rather to sour investors long term on stocks, so in the next secular bull market many will miss out on most of the gains, takes an over decade long process. Investors must suffer gut wrenching declines, with bull market cycles that merely take them to little better than breakeven, before plunging them back down into new bear markets. Secular bear markets psychologically grind investors down. More than a decade into this current secular bear market, investors are getting ground down. A natural part of this process is that investors will not be as euphoric at market tops.

Extreme Sentiment Elsewhere

There’s also another reason why investors don’t become as euphoric about stocks at market highs in secular bear markets, as they do in secular bull markets. The last two secular bull markets saw the broad market rise over 1,000 percent. Conversely, this current secular bear market has only recently made marginally higher highs than the 2000 top. This is quite a contrast in wealth creation, and it goes a long way in explaining why investors get more greedy during secular bull market tops, than what we are currently experiencing. Investors like to chase performance, and there just hasn’t been as much to get excited about in stocks for over a decade now.

This doesn’t mean investors don’t get very greedy during secular bear markets. They do. Just not so much for stocks. Investors congregate around the action. Before the modern stock market, the action and sentiment was concentrated around bonds, such as railroad company bonds when that technology was in it growth phase. Since the twentieth century during secular bull market periods, such as 1982—2000, the action is in stocks during those periods. But in secular bear markets, and specifically since 2000, the action has been elsewhere and so has the extreme sentiment. At the last market top, investors could hardly have been more optimistic and greedy when it came to real estate investments. For other investors gold became irresistible, although the yellow metal has recently been in a slump. Extreme bullish sentiment occurs around the areas that are surging the most and have not repeatedly disappointed investors, and real estate and gold in the last decade more resemble this state than stocks.

Misplaced Faith

Today, I would argue we are seeing extreme optimism when it comes to governments. A prime example is government pension plans, with many city workers the newest class of expectant millionaires in terms of promised retirement payments and benefits. And as a group they are still feeling greedy, rather than fearful. This is despite one of America’s largest cities in Detroit just filing for bankruptcy, during the midst of an economic recovery. Yet, every city that goes bankrupt is mostly seen as an anomaly, rather than the canary in the coal mine, warning of what will happen when instead of being in an economic recovery, the next economic downturn arrives. Government pensioners aren’t panicking about the precariousness of their own retirements, which any sensible accounting argues. Instead of shoring up dangerously underfunded pension plans, their unions remained focused on extracting more paper promises. In short they’re being extremely greedy, rather than appropriately fearful.

In my view investors are overly optimistic about government power on many points, particularly around government’s ability to intervene in financial markets: the European Union’s ability to hold its monetary union together; Japan’s ability to pursue monetary creation without destabilizing its debt situation; the Federal Reserve controlling long-term interest rates and creating growth through so-called quantitative easing; China’s ability to reignite growth when desired and avoid a financial meltdown. When such faith in government power is shown to be misplaced, it will have an impact on the stock market, just like misplaced faith in the strength of global real estate, credit markets and private financial institutions did in the last bear market.


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