Indications of Sentiment

When is sentiment fully reflected in market prices?  Who knows?  Today provided some interesting examples.

Housing Effect

CNBC featured guest analyst Jim Bianco, whose work we respect.  You can check out the video of his brief appearance, where he took the position that the market would not bottom until the housing market did.  His time frame for this was late 2008 or 2009.  He also cited the fact that there was a problem with bank lending.

We disagree in several respects. 

1. Markets will anticipate a bottom in housing.  Anyone waiting to see this will be far too late.
2. It is not completely about housing.  Issues related to spillover effects are quite relevant.
3. Bank lending is already improving from the Fed's TAF initiative.
4. Government policies take time to develop and market participants lose confidence.  Some of these proposals will be enacted and will help.

Many analysts are saying just what Bianco is.  It always looks good to highlight what has been happening.  Investors need to look forward.  Solutions are more difficult (and more profitable) to see than problems.

Specific Stocks

Jim Cramer today commented on Hewlett Packard.  He said that the PE growth was 13 and the PE was 13.  This is a nice PEG ratio, but he noted that "No one wanted to buy it." This is the essential definition of sentiment.  It tells one when to act -- when no one else does.

We noted similar comments today concerning Apple Computer Inc. (AAPL), Research in Motion, (RIMM), and Google (GOOG).  (Full disclosure:  We own AAPL and RIMM and we are buying more.  No position in GOOG or HPQ).

The idea is that everyone is piling into the "recession trade" and mutual funds are selling top holdings to satisfy the redemptions of individual investors, notorious for late reactions to market moves.

Conclusion

It is always difficult to step up when things seem the worst.  One always appears smarter and better-informed by discussing what has recently happened.  Despite this, it is more profitable and helpful to stick to fundamentals and the future, rather than history.

Comments

[Mike C]

FWIW, interesting article on sentiment:

http://www.bloomberg.com/apps/news?pid=20601087&sid=aDxnqV5lsbx0&refer=home

Clearly, sentiment is very bearish, which from a contrarian perspective means the correct position is to be bullish.

IMO, this is where things get tricky.

The technicals are negative, and most if not all indicators/chart patterns indicate that being bearish is the correct position.

But looking at sentiment you would have to draw the exact opposite conclusion. From the evidence I've seen, sentiment is better at predicting short-term moves/extremes, so what may be the case is that we are very due for a significant bounce upward before the negative trend resumes.

In any case, this is where IMO one has to use a little common sense and not make extreme bets one way or another. Random Roger on his blog pounds this theme correctly IMO. Either going to 100% cash or 100% double-leveraged index fund is just plain crazy.

IMO, there are stocks with reasonable valuations and good operating fundamentals that have nothing to do with subprime, housing, credit, or consumer spending. IMO, the biggest mistake is to frame these questions as ALL or NOTHING where you are either "in the market" or "out of the market". There is a huge middle ground that is most likely the best place to be.

[oldprof]

In addition to the quantitative indicators, there are plenty of other things to consider. My colleagues on RealMoney are almost unanimous in the lack of confidence in the Fed. Jim Cramer famously leads this group. Since Cramer is usually bullish -- and correctly so -- this is important.

One of Kudlow's guests tonight talked about a speech to hundreds where he asked how many were bullish. Six people raised hands.

Those of us who speak directly with investors hear the worry every day. These people all read the newspapers and watch CNBC where recession forecasts and odds dominate coverage.

It is difficult to look forward in such times, as I am trying to do here. Many seem to think that you are just out of touch. Let's check again in a few months.

As usual, I deeply appreciate the comments here, including those that contest our viewpoint.

Jeff

[Bill aka NO DooDahs!]

Jeff has posts on predicting rare events, but simply doing the math helps. The rarer the event, the better off one is just playing the averages, and the more accurate one has to be when using a predictive model. If 75% of calendar years are positive for the stock market, then one must have a documented accuracy of more than 75% to match the "accuracy" of somebody saying "the market will be up!" each and every year. Even an accuracy significantly higher than 75% may take years to show in the results, because it takes a large sample size (many years of annual predictions) to differentiate 75% from 85%. Similar with recessions, economic crashes, etc.

With something like annual U.S. stock market returns, where the average is around 9% give or take a point or two depending on which index you use and how many decades you include, and where the standard deviation of returns is close to twice the average, it doesn't behoove one to deviate far from the average – unless they're uncannily accurate. I would consider any prediction more than 1/2 to 2/3 of a standard deviation from the mean to be "excessively" bearish or bullish. Over +18% = excessively bullish => give me a darn good reason. Projecting a down year = excessively bearish => give me a darn good reason.

Projecting a down year multiple years in a row = idiot.

Chris, one more for you. AAII Sentiment Survey excessively bearish compared to long-term average. Twice as bearish as normal, with half the addition coming from both "neutral" and "bullish" categories.
http://www.aaii.com/membersurveys/Sentiment/SentimentSurvey.cfm

[Chris]

To inject some quantitative data as Mike C suggests:

The VIX is at 25.5: http://finance.yahoo.com/q?s=%5Evix

The ISEE Sentiment Index is at 86: http://tinyurl.com/2zs8du

The CBOE Put/Call ratio is at 1.2: http://www.cboe.com/data/IntraDayVol.aspx

I think these numbers suggest that sentiment is pretty negative.

[Shrek]

Participants seem to be getting less fearful on pullbacks which makes me worried. Everything is deteriorating and there is less concern than the last couple of pullbacks in the options markets. I would be ready for a 7-8 percent plunge one day.

[Mike C]

Assessing/gauging sentiment can be tricky IMO. My own view is that it is a mistake to try and determine if sentiment is mostly bullish or bearish based on a subjective evaluation of a few CNBC commentators/guests. I think one's view of sentiment is colored by their own perception.

Those who are bullish are going to tend to "zone in" on commentators who are negative as representing excessive negative sentiment while those who are bearish are going to "zone in" on commentators who are positive as representing excessive bullish sentiment. I lean bearish from a fundamental valuation perspective but at the same time try to respect the "message of the market" as represented by the technical factors (which has kept me on the right side of the market the past couple of years). Today I particularly noted a commentator who said the market would be up 30% in 2008. To me that seems like excessive bullish sentiment, but I realize I am biased so I ignore my own view in trying to determine what true sentiment is.

In my view, you have to go to the quantitative data like AAII, Investor's Intelligence, Market Vane, put/call ratios, and the VIX to get a "real picture" of whether sentiment is at extreme bullish or bearish levels. I'm not sure where most of those numbers sit at the moment, but that would give a better picture IMO of what the true sentiment picture is.