Thanks, Reid.
A very down-to-earth analysis.
<< ....one fact holds true to all in the list; a profit or potential profit in each of these stocks is why they attracted such a huge amount of cash in a very short time frame. >>
The stocks which rise based on actual profits are one thing. The confusing issue has always been those that the market bids up based on potential profits. These attract more and more attention, and it begins to appear that stock valuation measures are no longer relevant. IMHO, they are always relevant, in that if actual earnings fall short of expectations or profits fail to materialize within some reasonable time frame, then the illusion falls apart, and investor greed and excitement is replaced by impatience, boredom, and finally fear, and the market revalues the stocks according to traditional valuation measures. So to me, when a stock's valuation measures get bid way up, this is nothing more than anticipation of future events, and if these events turn out to not be true, then the market withdraws its bid.
<< Who will be left standing when all of the market smoke clears? It will be the companies who have a solid business
model and strong financial foundation with future earnings growth potential. >>
Couldn't agree more. Also, these will tend to be safer havens, particularly those solid companies which are currently relatively undervalued.
I've always believed that, sooner or later, the market and all its component companies must regress towards two fundamental (though interrelated) driving forces: earnings, both current and projected; and the fundamentals of the underlying economy in which it operates.
Problem is, there's temporary deviations from these, driven by either greed or fear, which always tend to confuse, particularly if those deviations are large. When this occurs, the talk always seems to be, "This time it's different. This is a New Age, and you can't compare this with anything that has happened before, and that's why the valuations are so much different than anything that has previously been the norm. Old Economy companies will continue to be valued the old way, but the market will judge New Economy companies with the New Metric."
And the common thread is that as it invariably turns out: No, sorry folks, but this time just like all the previous times it's not different.
And thanks for the sentiment indicator. Investor sentiment is, IMHO, a much-neglected but critically important analytical tool. It is one of the best ways I know to get a quantitative or semi-quantitative handle on the two major short-term driving forces for stock price and market direction: greed and fear.
It's gratifying to see investor sentiment swinging southward in the graph, i.e., becoming more bearish. The magnitude of that from the center line compared to other previous lows (which immediately preceded major market advances) is consistent with my notion that a major market bottom has not been reached, though a short-term rally appears to be in the cards.
But the graph shown is really just a limited poll of investors, probably mostly irrelevant investors, in that I doubt the big boys participated in the survey. Investor sentiment should therefore also be evaluated in other ways.
IMHO analysis of equity put/call ratios is an excellent way to gauge sentiment, because that more accurately represents in quantitative terms the perceptions going forward of all investors, institutional and retail. But by virtue of their sheer weight, put/call ratios in major stocks and indices tend to be dominated by big institutional/professional investors, whose effect on put/call ratios tends to overwhelm the effect of retailer sentiment.
Once you get a handle on the sentiment of big smart money going forward, then I think it wise to look for discordances between these and sentiment primarily reflecting retail investors. The chart you posted is probably a good one here. Another is the relative amounts of money flowing into bull vs. bear mutual funds.
So what might investor sentiment be at the moment?
Consider this: The CBOE Equity put/call ratio on 12/14 peaked at 0.861, the highest (i.e., most bearish) reading since 10/18, which coincided with a short-term bottom in the COMPX at 3026:
stockcharts.com[L,A]DBOLNYMY[DB][PB25!B50!B100!B200!F][VC60][IUC20!LB14!LF!LG!UA12,26,9!LJ[$SPX]]
Market trend reversals are very reliably correlated with extreme reading in the equity put/call ratio, and the more extreme the readings, the more reliable the signal. So the current equity put/call suggests to me that a short-term bottom is in place, and a short-term rally will now ensue. But by historical standards, this reading in the equity put/call ratio is woefully inadequate as a signal of a general market trend reversal, and before this can occur, the equity put/call, and particularly the 20 day moving average of the put/call, must achieve levels well in excess of 1.00.
What about other indicators of investor sentiment?
The Rydex Nova/Ursa ratio compares the NAV-adjusted relative amounts of money in two clearly oriented mutual funds primarily composed of retail money: Rydex Nova Fund (bullish) and Rydex Ursa Fund (bearish). This ratio now stands at 0.45, and has dropped from 0.56 on 12/11. This means that more primarily retail investors are putting money into the Ursa Fund compared to the Nova Fund, and so retail sentiment has gotten somewhat more bullish. Extreme readings in this ratio, like the put/call, have increasingly reliable contrarian significance, in that market reversals and the beginning of new market uptrends are characterized by a climate of extreme pessimism and fear, while market tops are characterized by extreme optimism and greed. A reading of 0.45 is not extreme, and somewhat neutral, but the trend is more bearish, and thus this sentiment indicator would also be consistent with a short-term market uptrend.
Another useful sentiment indicator is the Average Analyst Allocation, which now stands at 66.9% stocks, 9.1% cash, and 23.5% bonds. This represents an increase from 63.9%/11.8%/23.4% on 10/6. The implication of this rise is that more funds are committed now to stocks, which has fueled the rally somewhat, but on the other hand the one major factor causing a true reversal and the beginning of a strong new bull market is massive money on the sidelines suddenly being invested into stocks. The capacity for this to occur is clearly diminishing, and will require a downwards allocation of money invested in stocks, and an upwards allocation of money invested in cash/bonds. This I see as unlikely, particularly given that bond investments will be seen as increasingly lucrative in what is shaping up to be a downward interest rate environment.
Another useful sentiment indicator is the Consensus Index of Bullish Market Opinion, published weekly by Consensus, Inc. This indicator gauges futures traders sentiment, more representative of big money sentiment since retailers do not participate to a significant extent in the futures markets. The component of this index which deals with the stock market reflects the sentiment of stock index futures traders, and stands now at 27% bullish. This has declined steadily from 41% on 10/6, but did reach an intervening low of 25% on 10/20, again at a short-term low in the COMPX, and another low of 28% on 12/1, again roughly coinciding with a short-term market bottom. The current reading of 27% is again consistent with a short-term market uptrend.
But once again, these readings are not even close to the extreme levels of pessimism typically seen at a market bottom.
There are many other ways to evaluate sentiment, but this is more than enough for now, I think. The emerging, consistent picture from the standpoint of sentiment is that a short-term rally is imminent, but that a true market bottom is a long way off, sentiment-wise. How far this may be chronologically, I couldn't say, but I don't anticipate a true bottom for perhaps a year, maybe more.
As always, JMVHO..................
Terry |
