Bullishness On the Rise


Investors confront a lineup featuring the usual suspects: Europe's ongoing debt crisis, the risk of China downshifting its giant growth machine, and the patchwork U.S. economic recovery. Despite those drags, about 47% of newsletter editors are bullish, up from 43% a month ago and 34% two months ago. Bulls now outnumber bears by nearly 18 percentage points, says Investors Intelligence.

The current environment contrasts sharply to early October, when Investors Intelligence counted more bears than at any point since March 2009, the market's nadir. In early October, the Dow Industrials and S&P 500 Index hit 52-week lows.

When sentiment careens toward either extreme, contrarian investors prepare for the market to move in the opposite direction. Investors Intelligence says once bullishness tops the 50% threshold, stocks enter dangerous territory. For now, expectations remain in check, with 23% of editors believing the market is in the midst of a correction.

Concerns about the market's near-term direction has contributed to the flow of money from stock mutual funds. In the week ended Nov. 30, equity funds suffered their fourth straight week of outflows, with investors withdrawing $3 billion. Meanwhile $7.9 billion flooded into money-market funds.

The Elliott Wave Short Term Update calls the market oversold and compares it to a beach ball held under water. "When it manages to squirm away from your hand it will quickly pop out of the water."

European drag

In recent months, U.S. markets have been at times held captive by headlines coming from Europe, "where a downturn seems probable," says The Value Line Investment Survey. Standard & Poor's echoed that pessimism in December, placing 15 European Union countries on negative credit watch, suggesting there is at least a 50% chance that such economic stalwarts as Germany and France will lose their prized AAA ratings.

A recession in Europe would weigh on U.S. exports and corporate growth, endangering hopes for a sustainable recovery. Blue Chip Economic Indicators cautions that U.S. economic growth could decelerate in the first half of next year versus the last six months of 2011. The Blue Chip consensus projects gross domestic product will increase at annualized rates of 2.3% in the December quarter and 2.1% in 2012.

Another obstacle facing the U.S. economy is its own political gridlock. "The Fed appears to have shot all its bullets, and the Obama administration is unlikely to spend additional money when the Republican party intensely criticizes any spending," says Intelligent Value. "With an election next November, the likelihood of more spending to boost the economy is low." Given the unbalanced recovery, the economy might not yet be ready to pedal forward quickly without the Fed's training wheels.

But while slowing growth isn't good news in itself, few pundits are projecting a double-dip recession these days, and encouraging economic indicators are starting to appear. The Value Line Investment Survey rattles off a list: housing starts, home sales, the opening to the holiday retail season, and a gain in consumer confidence for November.

The Forecasts isn't ready to jump on the bullish bandwagon just yet. But the Dow Industrials and Transports have risen to within 0.8% of their late-October highs. And if both averages close above those highs, the Dow Theory would turn bullish.

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