Saturday, February 2, 2013

Equities In Euphoria!

Just some quick charts today. It has come to my attention that some of the sentiment surveys and various other contrarian indicators I follow have moved from high bullish levels, usually found at intermediate tops, towards euphoric levels, which are usually found near the end of bull markets.

In my opinion, the current feeling of the market and the mood of the market participants is much more closer to that of 2007 than 2009. We have come a long way in this bull market, and the majority of investors have missed out on the gains. These investors are now piling in with both hands and feet.

They are the ones quoting various fundamental "good news" and various reasons as to why equities will go higher. However, these investors were no where to be seen during the panic of 2008, when fundamental "bad news" pointed as to why equities will go lower. It was wise to be buying during the late 2008 crash and it was also wise to be buying in the early parts of 2009. Buying equities today is a fools game.
"The wise man does at once what the fool does finally." - Niccolo Machiavelli
Consider the following:

Chart 1: It's that old "market top" feeling...
Source: Bank Credit Analyst / Frank Holmes

Do you remember what 2007 felt like? No, really... do not just answer quickly, but actually think about it for a second. Think about the constant bullish media news (present today), analysts quoting good fundamentals (present today), strategists predicting ever higher price and earnings targets (present today), speculators relaying on liquidity (present today) and retail investors running around conferences like "headless chooks" worried that they will miss the next big move (present today).

Bank Credit Analyst recently wrote about this, stating:
"Sentiment among individuals, advisors and traders has experienced a sudden spike recently. Its latest Bloomberg numbers show that 53 percent of those surveyed expect equities to be the best-performing asset class over the next year. This represents a 17-point jump over the previous poll in November, and the highest reading in the four-year history of the survey."
Frank Holmes goes on to write:
"My anecdotal experience this week at the World Money Show in Orlando, Florida supports the view that investors are going “all-in” for equities, as the exhibit hall and conference rooms were packed with thousands of enthusiastic investors looking to gain insights."
Now, does that remind you of the market bottom in 2009 or the market top in 2007? Other much wiser contrarian investors share the same concerns too. In his latest newsletter, just received this morning (Asian time), Marc Faber writes:
"The fact that hardly anybody can see why stocks would decline makes me very nervous (9 months ago, nobody could see why European stocks would rally). Furthermore, it is noteworthy that some hard core bears who missed the entire 2009 – 2013 rally are now positive about stocks."
Chart 2: Fund managers are "all-in" plus some!
Source: Short Side Of Long

The extreme group-think attitudes within sentiment surveys usually signal the end of the rally, rather than its beginning, as markets tend to correct and surprise the majority. The recent data from the National Association of Active Investment Managers (NAAIM) has just done that - signalled that we are currently in the midst of major bullish group-think. The average fund manager is now holding 104% net long exposure (record high), meaning not only are the managers "all-in", but they are now also leveraging up as they anticipate further gains ahead.

Furthermore, the most bearish managers, usually known as hedgers tend to almost always hold short exposure just in case the market declines. But now, even these guys have thrown in the towel and for the first time in the survey's history, the most bearish fund managers hold a 60% net long equity exposure. Basically, the bulls are bullish and the bears are also bullish.

Chart 3: Advisors most bullish since 2007 top
Source: Elliot Wave

According to Elliot Wave and Market Vane's Bullish Consensus survey, newsletter writers and market advisors are now turning extremely bullish on future market prospects. The chart above shows that at 69% bulls, we are only a couple of percentage points off the bullish readings we saw prior to a major top in 2007. Furthermore, readings around 69% have occurred just prior to the intermediate corrections of March 2012 and September 2012. 

Chart 4: Speculators are at record optimism

Source: SentimenTrader

There are usually many types of investors when it comes to the stock market. However, the two most prominent ones in the US are those that invest in blue chip large cap names found in the Dow Jones Industrial index or the S&P 500 index; and then there are those who tend to invest into higher beta Technology stocks. In my opinion, it is always a valid strategy to track the mood of these tech speculators, who more often than not tend to chase rising markets and short into falling market - and at major turning points they tend to be awfully wrong.

The first chart above shows that according to the Hulbert Financial Digest, advisors and newsletter writers who cover Technology stocks are recommending their client to put over 81% of all funds into work. This is one of the highest readings on record and has only been witnessed a handful of times over the last decade or more. Usually what proceeds these kind of readings is a consolidation at best or even a market crash at worst.

The second chart above shows that Japanese margin traders (usually considered to be a dumb money contrary indicator) are now profitable. Sentiment readings like the one shown above usually occur at or near major market tops. The fact that this is the highest ever reading, makes it even more concerning.

Chart 5: Risk Appetite reaching euphoric levels!

Source: Credit Suisse

Finally, the last chart I want to share with you today is the Credit Suisse's Risk Appetite Index, which has now reached levels of euphoria, far surpassing the high bullish levels in March 2012. The chart is pretty self explanatory and together with all the previous charts, plus many more indicators not included in this post, signal that the stock market is now in a period of euphoria.

While I have considered other scenarios (not just recently, but also prior to engaging into short positions last year) I continue to hold a strong conviction that the next major move for the stock market is on the downside. I believe that a major sell off correction is now overdue and it is a fools game to be investing into the stock market this late in the business cycle. I urge you to let "headless chook" retail investors pile in without following them, while you wise up!

What I Am Watching