I like to keep an eye on sentiment indicators.
It’s interesting to know how other investors feel about what’s going on in the markets. After all, markets are driven by human beings, and human beings are in turn driven by a lot more than just rational analysis of the numbers.
One popular measure of sentiment, published by Investors Intelligence, takes the views of newsletter writers, and categorises them as bullish or bearish, or somewhere in between.
If an extreme number of writers are bullish or bearish, then that’s often a contrarian indicator. If everyone’s bullish, there are no more buyers in the market. If everyone’s bearish, no more sellers.
The indicator is neither overly bearish nor bullish at the moment. But one aspect of the survey is at extreme levels – and it says a great deal about the state of the current market…
The Fed controls the equity market
A recent piece from Jim Bianco of Bianco Research highlights an interesting development in the Investors Intelligence survey of newsletter writers.
As at the end of May, the percentage of bearish writers – defined as those expecting a fall of 20% or more in the market over the next six months – is close to “the lower end of its historical range”.
So is the market mega-bullish? No. “The percentage of bulls is also low and on the decline.”
So where is everyone positioned? Investors Intelligence also measures the percentage of writers “looking for a correction in an ongoing bull market”. These writers expect a decline of at least 10%, but followed by a rebound.
It turns out that “the number of newsletter writers in this camp is near an all-time high”. In other words, the favoured position just now is to sit on the fence.
This probably shouldn’t come as a surprise. As Bianco notes, the overall news has been pretty bearish. US data has weakened, and the ‘long emergency’ in Europe just keeps going.
But the problem for the bears is that the Federal Reserve could turn around and pump money into the system at any point. And the worse things get, the more likely that becomes.
However, the worry for the bulls is that while the underlying economy still looks grim, there’s no way of predicting exactly when the Fed will do more money printing. And there’s always the chance that it won’t.
So overall, investors now seem to be betting that things will probably deteriorate from here, but that at some point the Fed will have to step in to put a floor under the market. Either that or Europe will pull some sort of deal out of its back pocket and give the market a bit of relief that way.
Fed chief Ben Bernanke might feel pleased by this. He might not be able to do much about unemployment, or the US housing market, but he’s got equity investors well trained. No one wants to ‘fight the Fed’ these days.
But if he has any insight at all, he should be worried. At best, it shows that the Fed is preventing markets from reaching a ‘clearing price’. In other words, most people think the market should be lower, and they’re only resisting betting in that direction because they’re afraid the Fed will stomp on them if they do.
At worst, the current situation is actively putting investors off equities. They feel that the markets are becoming a casino. All your hard analysis counts for nothing if the ultimate direction boils down to how aggressive Bernanke is feeling that day.
What really matters in investment
It’s really quite depressing. So what can you do about it all?
The best thing – hard as it may seem – is to try to ignore the shenanigans of central banks and concentrate on what matters: finding value.
If history shows anything, it’s that you make money by buying markets when they are cheap, and you lose it by buying when they’re expensive. This is why, for example, I’ve started – cautiously – dripping a bit of money into Europe, and Italy specifically.
You can find out more on why we think Italy is the most promising peripheral market in the current issue of MoneyWeek, but what it really comes down to is that the market is now pricing in an awful lot of pain.
It may take a while, and it may fall further, but I expect that in the longer run – years, not months – buying now will turn out to be a good idea. But I’m keeping it to a small part of my portfolio just now, in case I’m wrong or too early.
As for individual stocks, I still like those big blue-chip, decent dividend payers that we’re always talking about. And I still think you should have a decent bit of cash on the side for as and when bigger opportunities arise.
But if you prefer to stick with funds and leave the stock-picking to someone else, then don’t miss the latest issue of MoneyWeek magazine, out tomorrow. My colleague Merryn Somerset Webb has put together a model portfolio constructed from six investment trusts.
All six trusts have good track records, are London-listed, and are easy for UK investors to buy. We believe that together, they make up the basis of a solid core investment portfolio. Make sure you get your copy – if you’re not already a subscriber, subscribe to MoneyWeek magazine.
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