Rather than leading market trends, market sentiment indicators are following market prices.
The major equity indices have been stuck in relatively narrow trading ranges and the largest reading of American Association of Individual Investors sentiment poll has been stuck in neutral.
Money market levels, as reflected by the Federal Reserve Bank of St. Louis, are climbing again and we think all of these indicators reflect liquidation by market participants who are moving to the sidelines.
Many investors seem to be obsessed with well-publicized bearish calls such as the recent one from bond trader Bill Gross.
According to these Cassandras, doom awaits anyone foolish enough to remain invested in common stocks.
It brings to mind another old Wall Street chestnut: “There is no one more bearish than a sold out bull.”
Many of these commentators have benefited handsomely from the latest bull market and now have decided that it is time to cash out.
They may be right, but we disagree for several reasons.
While we admit that valuations are historically high, we do not believe that valuation alone is an effective market- timing tool.
In fact we believe the real money is made by identifying the long-term price trend and sticking with it, not trying to anticipate its change.
Further, we believe trend analysis is more a technical exercise, not a fundamental one.
Therefore, to forecast a change in trend we would rather rely on signals from the market, rather than the economy.
To signal a change in trend we would look for a halt in upward momentum before the price trend turns down.
That would involve a correction in price that at least broke the lower bounds of the current trading range, now around 2000 to 2050 on the S&P 500 Index.
If the market were to do so and then fail to set a new high on the ensuing rally, we would recognize that as a change in trend.
Until that happens, we will ignore calls for a market crash based solely on ego and economic news.
That does not mean we are bullish on all sectors or all stocks in the market.
We recognize that as this market ages many of the smaller capitalization stocks are no longer participating in the advance.
We recognize that crowded plays such as biotech and social media stocks are extended and will be very volatile.
Waiting for Signals
We even believe that investing overseas presents better growth opportunities as the world continues to experience the currency wars between various trading blocs.
So while we wait for the domestic fundamentals to catch up with domestic market prices, we will remain invested.
We know that sooner or later the market will break out of its trading range.
But rather than pontificate on when, or in which direction, we will await a signal from the market itself.