Sentiment Far From Euphoric

6/22/2015


While the outlook for the stock market is a bit muddy, the state of the Dow Theory is crystal clear:

• With rebounds to new highs above 18,312.39 in the Dow Industrials and 9,217.44 in the Dow Transports, the bullish primary trend would be reconfirmed.

• With a breakdown below the Jan. 30 closing low of 17,164.95 in the Industrials, recent new lows in the Transports would be confirmed — and the primary trend would be regarded as bearish.

A move above 9,217.44 in the Transports would require a rally of more than 10%, while the Industrials are only 4% from a move below 17,164.95. But the Dow Theory will remain in the bullish camp if the Industrials can hold above 17,164.95, so moving into a bear-market posture seems premature.

Instead, subscribers should hold about 15% of their equity portfolios in a short-term bond fund while watching the averages. Also, look beyond the averages for clues on where we stand in the market cycle. Historically, bull-market tops have been associated with rich stock valuations and unusually bullish investor sentiment.

As we argued on pages 1 and 3 last week, stock valuations are high relative to historical norms — unless you adjust for today's low interest rates. As shown in the table below, average and median price/earnings ratios for stocks in the S&P SmallCap 600, S&P MidCap 400, and S&P 500 large-cap indexes are 5% to 15% above the norms since October 1994.

MEAN AND MEDIAN PRICE/EARNINGS RATIOS
----- S&P 600 -----
----- S&P 400 -----
----- S&P 500 -----
Average
Median
Average
Median
Average
Median
Recent trailing P/E
24.6
20.7
23.7
20.5
21.7
19.6
Norm for P/E since Oct. 1994
21.6
18.1
21.4
18.0
20.8
18.0
Recent as % of norm
114
114
111
114
105
109
% of month-ends lower
than recent since Oct. 1994
94
85
89
89
65
79

Investor sentiment, however, is far from bullish extremes. In fact, the percentage of bulls in the weekly survey by the American Association of Individual Investors recently hit 20%, only the fourth time it has been so low in more than 20 years.

INVESTOR SENTIMENT
Bulls
Bears
Bull/
Bear
Ratio
Recent percentage
20
32.6
0.6
Norm since 10/94 (%)
40.9
30.2
1.6
Recent as % of norm
49
108
38
% of weeks lower than
recent since Oct. 1994
0
63
7
Source: American Association of Individual Investors.

Among the newsletters monitored by Investors Intelligence, the percentage of bulls is at six-month lows and slightly below the norm since October 1994. While the percentage of bears is relatively low, the percentage calling for a correction is at six-month highs and well above historical norms.

NEWSLETTER SENTIMENT
Bulls
Bears
Bull/
Bear
Ratio
Recent percentage
45.5
16.5
2.8
Norm since 10/94 (%)
47.6
28.4
1.9
Recent as % of norm
96
58
147
% of weeks lower
than recent since Oct. 1994
36
6
86
Source: Investors Intelligence.

According to Bank of America, Wall Street strategists are still recommending an unusually low allocation to stocks. In fact, the equity allocation is lower than it was at the bear-market lows in March 2009.

Conclusion

Bullish sentiment is far from the levels typically seen in stock-market bubbles. While not all bull markets end in a greed-fueled bubble, many do.

For now, subscribers should watch the averages, hold about 85% of equity portfolios in stocks, and look for opportunities one stock at a time.

 


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