Friday, July 26, 2013

A Few Words on Sentiment (and FIPIA?)

I keep tabs on sentiment figures, but I don't let them overly steer or influence my actions. While I absolutely respect the contrary warnings conveyed, sentiment can remain excessively bullish (bearish) during long protracted rallies (declines) and therefore I've never found such figures to be especially precise in their timeliness. As I said, they're definitely worth tracking and keeping in mind but should be considered only as another input amongst many in your process. I maintain a weight-of-the-evidence approach tends to work best in all environments, achieving the most consistent above-average results over time.

It's worth stating again, as with markets, sentiment can remain at very high (bullish) or low (bearish) levels for longer than you think. That said it is at historic extremes that sentiment figures become most timely, often indicating an asset or market is completely washed out on the downside or at a climatic peak to the upside. But even in these cases, it pays to use other tools and methods to assess trend, momentum and a likely turning point. More accurate calls will be the end result.

A case and point: gold (and gold miner equities for that matter). In January and February, sentiment for gold hit an extreme level of bearishness -- when the price of gold was still well above $1600. To have acted simply on the contrary call of sentiment would have been a costly mistake.

Another fact to consider is these days there are several representations of sentiment, which can often times portray differing pictures. There are surveys, polls, put/call ratios, fund manager cash levels, just to name a few. And with surveys and polls, results can vary depending on who is being asked for their opinion: traders, portfolio managers, individual investors, etc. Again, a weight-of-the-evidence approach is advisable, look to arrive at an overall consensus.

In a more macro sense given today's environment, I fully appreciate that with the market's historic YTD rally, more than a few sentiment measures have registered frothy bullish extremes, suggesting a top is nigh. Perhaps. I wrote on July 17th that for several reasons I felt the S&P 500 would successfully achieve a new high, which it did, but now what? (More to come on this subject early next week). But with regards to sentiment in general, I'm not sure I sense the elevated euphoria that at least some sentiment figures suggest is the current state of the collective investor psyche. I know market tops are established when least expected (i.e. when all is good), but apart from the stock market itself doing quite nicely, in my opinion stock prices continue to climb a wall of worry -- which is a bullish backdrop. Granted, investor concern was greater when the market was lower many months ago, but I wouldn't say that we have flipped the switch to euphoria or giddy optimism. In fact, not long ago the market was very jittery due to talk of the Fed tapering QE activity. I would argue that thanks to the Fed and our ever-recovering economy, nervousness remains the only constant for this market, which to reiterate is a bullish component for any market. If the economy was cruising along, unemployment was at or below 6.5% and the Fed was no longer needed as a necessary crutch, that is when I would become much more concerned. But we know this is far from the present reality.

So in the meantime, for lack of a better term, we have FIPIA: Fed-Induced Perma-Investor Anxiety. Yes, sentiment will rise and fall as the market rises and then retreats (nothing ascends forever), but as for a deeper and more ingrained reading on longer-term investor psychology, I believe the lasting uncertainties of our economy along with the incessant guessing games involving the Fed will continue to foster nervousness in varying degrees. And as long as that's the case, the proverbial wall of worry will remain in place for the market to presumably climb.

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