More Advisors Say US Stocks’ Direction Is Up – A Warning Signal? No!

Friday, April 16, 2010

The bears’ endeavors to predict the end of this rising market keep getting squelched. They want to believe there is some wrong-headed reason for stocks going up. Unfortunately, for them, the cause of this stock market’s gains is improving fundamentals: The economy (economists now are changing their tune and upping growth forecasts) and corporate earnings (e.g., Intel’s good earnings news spread to other technology stocks).

But the bears keep trying. Here are the latest attempts.

Bloomberg gets it wrong with mutual fund cash

Last month, Bloomberg raised the issue of low mutual fund cash reserves. “S&P Rally Slowed by Fastest Cash Depletion Since 1991 (Update3)” (Bloomberg, by Lynn Thomasson, March 8). They and others pointed out that the last time the level was so low (2007), the market dropped a lot. That simplistic comparison overlooked the difference between today’s and yesterday’s conditions. Back then, US stock investing was popular, with a 5-year run and mutual fund managers needing to stay fully invested to compete. (Cash drags down returns, so managers attempt to keep small cash amounts during a bull market.) Today, these same managers aren’t seeing those conditions. Rather, they are looking at an improving economy, growing earnings pushing up stock prices, good stock valuations – all amid slowly improving investor inflows. These conditions are driving them to use any excess cash, so as not to miss out on the values and the rising market. The graph shows that the mutual fund managers got it right – and the bears did not.

Lower trading volume is a characteristic of the market, not a sign of the top

Then many bears started saying that the market’s rise on lower volume is problematic. However, they are again not taking into account today’s market characteristics. The market is thus far rising in a steady, controlled manner (you can see that pattern in the graph above). Steady markets do not provide as many trading opportunities as volatile ones, so trading volume naturally declines.

Also, the idea that healthy price rises require volume to push them up is wrong. If a company announces important news overnight, the stock will open at a different price, adjusted for the news. A stock doesn’t need to be bought or sold to change; it just needs to have the bid/ask shift based on news.

And that news today is earnings. Even with low volume, changes in earnings (actual or forecast) can cause a change in price. Otherwise, valuation would change – and that requires a change in buyer or seller activity. In other words, if prices rise faster than earnings, then we expect to see a volume increase as investors bid up stocks.

I have talked about this earnings period possibly reigniting investor interest in US stocks. The advisor sentiment readings could be sign of that.

More than one-half of advisers are now bullish

Market Harmonics tracks a number of indicators. One of the best is the Investors Intelligence US Advisors Sentiment Index. (It is considered a contrarian indicator at extremes. When advisors are very bearish, it can be a good time to buy, and vice versa.) While the March 2009 advisor bearishness has dissipated, bullishness has been slow to increase. This week, however, it rose above 50%. Hmmm… Could this be the next bear story?

If so, we will read that this bullishness could mean the market is topping. Actually, it could mean that the long period of advisors’ neutral or ambivalent interest in US stocks is ending. Market tops don’t occur simply because more than half are bullish. And, with so many investors underweighted in stocks (see graph below), we could see an unusually strong shift to bullishness that doesn’t indicate a market top, but represents a broad shift in attitude towards US stocks. We need not worry about over-bullishness until individuals and institutions are back to full US stock allocations – or more – and everyone is again talking about how great US stock investing is.

Investors at risk from US stock market? Not until US equity mutual fund flows rise in a big way and for an extended period.

So… The earnings push appears to have started. With advisor bullishness rising, investors’ US equity flows could follow.

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