Where Are the Bears?
This is the question asked by the Macrobusiness blog in Australia. It presents the charts showing the current bear percentages of the Investors Intelligence (II) and American Association of Individual Investors (AAII) polls, which have recently declined to near record low levels. Note that at the same time the bull percentages remain well below previous record highs, so that the ratio of bulls to bears does not look as extreme as one might expect. Still, it is undoubtedly noteworthy that no-one believes there to be much downside. Once the II and AAII bear percentages fall below 20%, you are really only left with the perma bear hard core. In fact, what we find quite astonishing is that this dearth of bears has been extremely pronounced throughout the year:
Bear percentage in the II survey: it hasn't gone above 25% even once in 2013 – click to enlarge.
This is highly unusual; in the AAII poll, the bear percentage, which is currently at an extremely low 18%, at least spiked briefly above 50% on one occasion in early 2013 when the market suffered a small correction. Stock market advisors (which is what the II survey measures) have however been extremely consistent in their lack of bearishness. They have of course also been correct – but their persistence if of interest to us for a very specific reason as you will see below.
Mark Hulbert meanwhile informs us that the current HNNSI (Hulbert Nasdaq newsletter sentiment index) level is also at an extreme – it shows a rare peak in the bullish consensus of newsletter writers – although he cautions that this does not necessarily tell us anything about the long term trend:
“There’s little doubt that the bullish mood on Wall Street has reached dangerous proportions. But where I part company with some of my fellow contrarians is whether that means that the stock market’s primary trend is about to turn down. My research has shown that sentiment is only a short-term indicator, which means that the sentiment data do not enable us to forecast the market’s intermediate- or longer-term prospects.
Consider the average recommended equity exposure among a subset of Nasdaq-focused stock market timers tracked by the Hulbert Financial Digest (as measured by the Hulbert Nasdaq Newsletter Sentiment Index, HNNSI). I focus on this subset because these advisers are particularly sensitive to perceived changes in the market’s direction — and are therefore good barometers of the prevailing mood.
The average equity exposure among these advisers currently stands at 93.8%, which is tied for the highest it’s been in quite some time. As you can see from the accompanying chart, the Nasdaq Composite Index has been close to a short-term top every time over the last two years when the HNNSI previously approached its current level.
(emphasis added)
This the chart of the HNNSI since early 2012- as you can see, this is indeed a quite sensitive measure:
Mark Hulbert's HNNSI reaches an extreme level of exuberance.
Now, we agree with Mr. Hulbert that this measure of newsletter advisor sentiment per se tells us nothing about the market's long term prospects. As he formulates it:
“[...] the irrational exuberance that is very much in evidence right now tells us little more than that the market is vulnerable to a short-term decline lasting little more than a month — maybe three.
Note carefully that this does not mean that such a pullback couldn’t develop into something more major. When the next bear market does eventually begin, of course, it will start with a short-term decline. My point instead is that, if a bear market does begin, it won’t be because of exorbitant levels of bullish sentiment.”
(emphasis added)
Secular Bull Markets and Sentiment
As noted, we agree in principle with Mr. Hulbert, but there is one additional point that needs to be considered. If the market has entered a long term uptrend, then it can no longer be classified as a mere cyclical bull market – it will then have to be re-classified as a secular bull market (a number of people have actually recently done exactly that – see e.g. this interview with Charles Schwab strategist Liz Ann Sonders. She is not the only one).
Our feeling is that most of the people who argue that a secular bull market has begun were probably not around at the beginning of the last one. If they had been, they would remember two features that accompanied the beginning of the amazing bull run in 1982 (or 1974, if one wants to use the nominal bear market low as one's starting point). The first one was that valuations were actually extremely low. The market's valuation at the lows in 2008 and 2009 was a far cry from the types of valuations we have historically seen at secular bear market lows. That was by the way completely independent of the level of interest rates. Valuations were extremely low both at the end of the 'deflationary' secular bear market of 1929 to 1949, when interest rates were at rock bottom levels, as well as at the end of the 'inflationary' secular bear of 1966 to 1982, when interest rates were extremely high. Market valuations in the form of trailing P/E's had been in single digit territory for several years in both cases, market cap relative to asset replacement value, market cap relative to GDP, or any other yardstick one might want to consider in the context of valuation, was a fraction of what it was at any time in the past 13 years (from the point in time when the secular bear period began in 2000).
However, we want to leave the valuation argument aside here and concentrate on sentiment. Was there a difference to today? Is it true that sentiment is only a valid indicator of short term performance, or could there be more to it?
Readers who personally experienced the 1970s and early 1980s may remember that sentiment was in fact extremely subdued for many years. Not only was sentiment extremely bearish for a number of years prior to the bull market's beginning, it remained highly skeptical for a long time after the new bull market had already begun. People no longer believed that there would be a new bull market before it actually started, and once it was well underway, they kept doubting its staying power.
Almost no-one was talking about a 'new secular bull market' when the market bested its old highs back in 1983-1985. This technical breakout elicited scarcely any comment – we remember the time clearly. Robert Prechter was one of the few people who were extremely bullish at the time and he was widely thought of as an incurable eccentric. In contrast to today, the economy was actually moving ahead with vigor. There was very strong economic growth in the second half of the first term of the Reagan administration, which continued through Reagan's second term. Interest rates had embarked on a clear downtrend from very high levels, and still people had a hard time believing in the bull market (their doubts increased strongly again after the 1987 crash).
In order to see the difference to the 2000-2013 period, take a look at this long term chart that includes four years of II sentiment data prior to 1982. Note specifically the bear percentage.
II sentiment survey, long term. Prior to the beginning of the bull market in 1982 and even for a good while thereafter (especially the time following the 1987 crash), the II bear percentage was vastly higher on average than it has been in the 2000-2013 period, with the brief spike in bearishness in 2008 representing the only exception – click to enlarge.
We believe therefore that there is actually some information about the market's likely long term performance conveyed by sentiment data as well. Although sentiment polls and other sentiment and positioning data are only available for a comparatively short slice of market history, the idea that new bull markets are greeted by disbelief was known well before such data were compiled. This remains one of the main differences between today's market and the markets of yesteryear: since the tech mania peak in 2000, we never saw the valuation and sentiment extremes that are typically seen at the end of secular bear market periods. On the contrary, the data over the past few years are more consistent with those recorded near long term bull market peaks. Of course things don't have to play out in exactly the same manner every time, but one usually ignores market history at one's peril.
Positioning Data
We leave you with three more charts by sentimentrader that show current speculative positioning. In NDX futures (all types combined), a new record high in speculative net long exposure has just been recorded – and the same is true of stock index futures overall. In fact, 2013 has so far been the year in which traders have positioned themselves for more upside to an extent never before seen in any year in futures market history. This extreme bullish consensus is not merely 'rare', it is unprecedented (yes, we know, 'everybody hates this market'). Keep in mind that we are talking about real money positions here, not about what people are saying in polls.
A new record high in the hedger net short position in all NDX futures combined (roughly the inverse of the record net long speculative position) – click to enlarge.
Commercial hedger net short position in all stock index futures combined, inverted chart (i.e. roughly mirroring the net speculative long position – note that this is not exact, as there are speculators holding various spread positions as well) – click to enlarge.
Lastly, readers may recall that we have shown a chart of Rydex assets in a recent update, including Rydex money market assets. Sentimentrader also produces a chart of Rydex money market fund assets, however, it shows them as a percentage of total Rydex assets rather than depicting their dollar value.
Rydex trader cash assets: at the very low end of the historical range – click to enlarge.
Conclusion:
It continues to be untrue that 'no-one likes this market'. In fact, we don't know about any other year in which the market has been loved as much as in 2013. We can see it in this year's Barron's 'big money polls', we can see it in sentiment surveys and in actual positioning data, including record high margin debt and recent near record inflows into equity mutual funds. Incidentally, in spite of mutual funds being inundated with a veritable flood of money, mutual fund cash reserves remain close to a record low as a percentage of assets, indicating continued high bullish sentiment among fund managers as well (this too was vastly different in the last genuine secular bull market, when fund cash reserves regularly spiked into double digit percentages).
Of course the bears have been quite wrong so far this year. Simply following the herd was clearly the thing to do (and it should be noted that since sentiment is in large part a function of price trends, one should expect sentiment to be net bullish in uptrending markets). Nevertheless, when sentiment and positioning data consistently produce new extremes month after month, it tells us that the eventual backlash is likely to be quite a doozy. Given that money printing continues as before, it is admittedly hard to see what could trigger a reversal – but this is also a 'hook' that is likely to eventually mislead market participants. They have become so used to the 'Bernanke put' supporting the market, that they can no longer imagine that it may one day not work as advertised anymore. And yet, it is a near certainty that this day will come. Stay tuned.
Charts by Marketwatch/Mark Hulbert, Sentimentrader, Decisionpoint