Are YOU a Contrarian Indicator?
Investments Tend to Surge at Market Tops
Did you invest money in the U.S. stock market last week?
If you did, you may have just bought a short-term top in stock prices. And you just might have to watch your investment fall into the red for a little while.
In other words, if you invested in the stock market after Congress finally came together to make the fiscal cliff deal... if you got long on the premise that the real estate market was turning up, interest rates would stay low, and the U.S. economy might actually have some upside...
Congratulations, you're right.
You may also be about to lose some money.
Now, before you start hurling expletives my way, let me explain myself...
Last week individual investors put an incredible amount of money into equity mutual funds. The $7.4 billion that went into emerging market funds was the most ever.
The $8.9 billion into “long-only” equity funds was the most since March of 2000.
Do you remember what happened on March 16, 2000?
Alan Greenspan raised interest rates by 50 bps. That was the beginning of the end of the Great American Bull Market. And it happened as mainstream investors were reaching a bullish frenzy.
In total, $22 billion went into equity funds and exchange traded funds (ETF) last week. That was the most since September of 2007.
I'm sure I don't have to tell you that was right before the financial crisis started to emerge.
Is it "different" this time?
Are investors wildly bullish today? It's safe to say they are not.
Total volume on America's stock exchanges like the Nasdaq and New York Stock Exchange (NYSE) are at multi-year lows. People just aren't investing as much as they once did.
On the one hand, we should be glad investors are warming up to stocks. Valuations are reasonable, corporate profits are at all-time highs, household balance sheets are improving, and perhaps most important, the Post Traumatic Stress from the financial crisis seems to be lifting.
I will go on record saying I am bullish on stocks for 2013 (but then, I've been bullish on stocks for the last couple of years).
I've been steadily positioning dividend-focused Wealth Advisory subscribers to benefit from higher stock prices and stronger dividends.
We've picked up Bank of America (NYSE: BAC) at $9 for 27% gains. We bought a sell-off in Starbucks (NYSE: SBUX) that's given us a 20% gain. Our global real estate fund, Alpine Global (NYSE: AWP) is up 29%.
We've also got several REITs that are up between 17% and 70%...
Not to mention the fact that all these stocks (except for BofA, where we anticipate a strong jump in dividends in 2013) pay good dividends.
Of course, the other side of the coin is this: When investors all start thinking the same thing, the stock market has a tendency to go the other way.
And when I see a quote like this,from strategist Michael Hartnett: “... whatever the reason, investors capitulated into equities this week,” my market Spidey sense goes on alert.
At stock market bottoms, the word “capitulation” means that the last holdouts finally give up and sell to avoid the pain of more losses. Once there's no one left to sell, the stock market can reverse and prices move higher. Conversely, when buyers capitulate, the assumption is that there's no one left to buy stocks.
However, these observations are overly simplistic. Stock market tops and bottoms are better described as a process, not a singular event. And I suspect that even though the stock market may drop a little as we move through earnings season, we will see higher prices this year.
As a counterpoint to the surge in cash into the stock market, take a look at this chart of investor sentiment from Bespoke Investments:
We can see that while investor sentiment has gotten bullish, it's not hitting any extremes. That's a good thing. With the Dow Industrials a stone's throw from all-time highs, the fact that sentiment is not at extremes suggests that we may actually see all-time highs for the Dow in the next few months.
In fact, I think we will...
Confessions of a Bullish Analyst
When I look around the stock market, I see plenty of skepticism.
How does one “see” skepticism? I look at forward price-to-earnings (PE) ratios. Forward P/Es tell you how much premium investors are putting on forward earnings estimates. If an investor believes future earnings will be strong, he or she will be willing to pay a little more for those earnings.
I see plenty of forward P/Es that look really, really low — like Cisco (NASDAQ: CSCO).
Cisco is up 35% since July. The company's earnings have stabilized over the last two quarters, it's boosted its dividend and increased its share buyback... and yet it has a forward P/E of 9.7.
The biggest gold miner and second biggest copper producer in the world, Freeport-McMoRan (NYSE: FCX), has a forward P/E of 7.7.
JP Morgan (NYSE: JPM) has a forward P/E of 8.7.
Ultra-stable Johnson & Johnson (NYSE: JNJ) has a forward P/E of 12. Does anyone think J&J will miss earnings? Probably not...
Even one of the great growth stories of all time, Apple Computers (NASDAQ: AAPL), has a very low forward P/E of 9.
To me, these low forward P/E ratios say investors believe forward earnings estimates will not be met.
And the reason is many investors are worried the U.S. economy can fall back into recession at any moment.
Maybe it will be because of Europe. Maybe it will be the Fed. Or inflation. Or China. Or the next fiscal cliff. Or derivatives. Or a huge meteor headed for Earth.
There are never any shortage of fear-mongering headlines.
I would go so far as to say the financial media has helped prolong the PTS from the financial crisis by constantly fanning the sensationalist “economic collapse” flames with their “if it bleeds, it leads” mentality.
Case in point: Just think how terrified everyone was about the fiscal cliff.
Was it really a huge deal? Or did 24-hour coverage just make it seem like Armageddon...
Speaking of the fear-mongering financial media, didn't I just threaten you with losses at the beginning of this article? Wasn't I playing to your fears, that you'll feel like you've been fooled again the first time stocks take a 5% plunge?
Why, yes I did. But I didn't do it just to get you to read this and pump our page views for high placement on Google's search results.
I wanted to deliver the message that, when stocks do drop 5% (and they will eventually), it doesn't mean you were fooled again, and the long-awaited economic collapse is at hand...
Rather, next time you see a correction in prices, use it to add some quality stocks at discount prices.
Starbucks at $50? Great. Cisco at $19? Love it. Bank of America at $10.50? Bring it on.
Until next time,
Until next time,
An 18-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.