Bullish Sentiment Nears Extreme Levels As Investors Pile Into Equities
Fortigent
By Chris Maxey
December 14, 2010
Equities push higher on positive economic data
It proved to be another positive week for the majority of risky assets with the S&P 500 Index rising 1.3% and the Dow Jones Industrial Average settling higher by 0.2%.
The most debated story, however, was not the continued melt up in equity prices but the recent melt down in the Treasury bond markets.
Source: Econoday
Over the course of the week, the 10-year Treasury bond saw its yield jump by 31 basis points, or 0.31%, to 3.32%. Some of this was due to a belief that an extension of tax cuts would result in higher than expected economic growth in 2011, causing increased inflationary pressure.
The employment picture received two favorable reports last week. The first came in the form of initial jobless claims. For the week ending December 4th, 421k initial claims for jobless benefits were filed, a drop of 17k from the week prior. To provide a smoother depiction of trends in initial claims, the 4-week moving average is commonly cited. That measure also dropped, reaching its lowest point since the middle of 2008.
Source: Federal Reserve Bank of St. Louis
In addition, earlier in the week, the Department of Labor released the monthly Job Openings and Labor Turnover Survey (JOLTS) for October. Despite the relatively weak nonfarm payroll employment report from a little more than one week ago, the JOLTS survey provided reasons for optimism. On the last business day of October, for instance, the number of unemployed individuals per job opening stood at 4.4, down significantly from the peak north of 6.
Source: Bureau of Labor Statistics
Consumers received a batch of positive and negative news on the week. Household net worth was up $1.2trln during the third quarter, which is finally translating into credit expansion. Consumer credit was up by $3.4bln in October, the first time credit outstanding rose in back to back months since 2008. Overall credit card debt remains on a downward trajectory, but non-revolving debt, such as auto and student loans is increasing.
Source: Econoday
Although their net worth is up, consumers’ pocketbooks might be feeling a shade lighter in recent weeks. AAA’s daily fuel gauge report shows that the national average for a regular gallon of gas is $2.98, the highest price in two years.
Source: FuelGaugeReport.com
At current prices, the Oil Price Information Service estimates that consumers will spend roughly $34bln on gas this month, up from $27.6bln in December of last year. With oil demand at a record high 88.3mln barrels per day, there is no reason to suspect prices will ease in the near future. A meeting of the Organization of Petroleum Exporting Countries over the weekend confirmed that suspicion as OPEC held production quotas steady in the face of rising crude oil prices. Saudi Arabia’s oil minister once again stated that they are very comfortable with current price levels.
Regardless of improving economic data, the stark reality is that a surprising amount of Americans are struggling merely to survive on a day to day basis.
The number of individuals participating in the Supplemental Nutrition Assistance Program (aka: “food stamps”) hit 42.9mln in September, equaling almost 14% of the overall population.
Source: Mish’s Global Economic Trend Analysis
as equities regain favor, is now the time to allocate?
News that Congress was close to striking a resolution on extending current tax cuts caused investors to believe that the economic recovery would be more robust than originally anticipated in 2011. That is causing investors to shy away from government bonds in favor of equity mutual funds.
According to EPFR Global, a research provider that aggregates mutual fund flows, the week ending December 8th saw investors allocate $13.7bln of new capital to stocks funds while only investing $146mln in fixed income funds. Domestic bond funds experienced withdrawals of more than $1bln. Interestingly, money market funds picked up more than $32bln in new funds, the highest total in 22 weeks.
Whether this is a wise time to jump back into equity securities remains a hotly debated issue but based on several metrics, this may not be the most opportune time to increase equity exposure.
To start, the number of stocks in the S&P 500 Index trading above their 200-day moving average is near extremely overbought levels at 85%. In order for that problem to correct itself, stocks would either need to trade flat for several weeks or experience a pullback.
Source: StockTwits
Additionally, the split between “smart money” and “dumb money” is near unusually wide levels. Smart money investors, such as commercial hedgers, are increasingly less confident on the equity markets, but dumb money investors are quite exuberant at the moment. It is quite rare for the dumb money index to hit 80% on a scale of 0% to 100%, but that is precisely where it stands right now.
Source: Zero Hedge, SentimentTrader.com
When the ratio between smart and dumb money crosses the 45% threshold, it is common for a correction to occur. In some instances, the correction did not happen for one to two months, but generally, over the next 50 days, the equity markets fell 0.8%. However, at the point when markets hit their peak, on average 14 days later, the markets experienced a correction of more than 6%.
Emblematic of the concern, 45% of indicators are sending extremely bearish signals and a mere 2% are in extremely bullish territory.
Source: SentimentTrader.com
While this is no guarantee of a correction and stocks could certainly trickle higher into the end of the year, it does represent a mosaic of unfavorable data. Corrections following extremes such as this are generally quick to play out, lasting a mere 34 trading days. This holiday season, investors may be better served by enjoying the light displays and forgetting about the stock market all together.
the week ahead
There are a number of key economic indicators to be released this week. Inflation trends will take center stage on Tuesday and Wednesday with the release of the Producer Price Index and the Consumer Price Index. Producers are being forced to absorb an increasing share of price increases, with little ability to pass those higher costs through to the consumer sector.
The Federal Reserve holds its regularly scheduled meeting on Tuesday. Economists and strategists alike are not expecting any change to current interest rate policy, but they will be looking for additional clarity surrounding the economic outlook and asset purchases.
On Wednesday, President Obama is hosting a CEO summit, with the goal of convincing CEO’s to part ways with their estimated $2trln stockpile in the form of hiring and investment growth.
The Organisation for Economic Co-Operation and Development will release a report detailing the European growth outlook on Monday. On Thursday, leaders in Europe will hold two days of meetings to discuss the debt crisis and additional solutions.
Several companies will report earnings this week, including Best Buy, Accenture, FedEx, General Mills, Oracle and Research in Motion.
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