Fading Mainstreet and the "people are bullish like in 2007" calls

Readers of this blog should know by now my disdain for Main Street's ability to predict the economy or the stock market. Main Street sentiment lags what is actually happening in the economy. Their opinions are formed based upon things like the unemployment rate - a lagging indicator and what they read in the popular media which tends to follow lagging or coincident indicators themselves. And think about it for a second....who better to know the least amount the economy and the stock market then your average Main Street Joe sixpack? The most successful hunters attack weak prey and when it comes to the jungle known as investing, Main Street is the weakest prey. So, you see...you don't have to have a PHd in economics or finance to be successful in this game. All you have to do is bet against the Main Street schmuck to win. Now, there's a correct and incorrect way of doing this. You need to realize that in the last 2-4 innings of a trend, Main Street tends to actually be in harmony with the trend i.e. they are right about it (but quite late). So for example, if you try to be a smart ass by betting against an uptrend in the market or a particular asset just because you see a lot of Joe Blow six packs positive about it, you run a high risk of getting your ass handed to you for being early. Just ask anyone who shorted tech stocks in 1999.

Most people don't use contrarian theory correctly. It doesn't work so well when the dumb money is in harmony with the trend because although these dummies will end up getting burned, they will actually be right for a while. Contrarian theory works best when you see significant dumb money resistance to an existing trend. Therefore, to fade Main Street with the highest probability of success do so when they are feeling one way about the economy but the stock market has been going in the opposite direction. This is what's happening right now.


Lately I've been seeing tons of evidence both anecdotally and in the media to support the notion that Main Street is still quite cautious about the economy/stock market. I talked about it here and here. Yesterday I got a back massage and I had an interesting chat with the masseuse. She asked me what I did for a living and as a result I found out that her mom, who's now retired, took up day trading about 5 years ago (near the market top of course) but now she does it "for fun". In other words, she took a beating and doesn't do much of it anymore. The masseuese then said "I know it's not a good time to be in the market". I didn't respond....no need to. But I wanted to thank her for this dumb money anecdote which adds to the pile of anecdotes I've come across lately confirming the same message.

Today there was an article in the National Post discussing a recent poll of 2560 Canadians asking them their outlook on the Canadian, US and global economy. Regarding the global economy (which was very similar to US results) 20% felt it would improve, 28% felt it would be unchanged, while 43% felt it would worsen (the rest didn't know). Another question asked was this: Which of the following best describes how you feel about Canada's economy? A chart was displayed which showed the results

Mild reccession: 55%
Strong reccession: 10%
Moderate growth: 30%
Strong growth: 0%
(I know, the above only adds up to 95%...not sure what happened to the other 5% but it doesn't matter)

So, you can see that the average Canadian still feels dour when comes to the economy. Notice that 2/3 of Canadians still think Canada is in a recession when in fact it has been out of one for well over a year now. Main Street in Canada is still well behind the curve. The stock market in Canada and the rest of the world have been soaring making fresh new 2 year highs while these guys are still down in the dumps.

Here's an interesting sentiment indicator which I just stumbled upon. It's called the Dow Jones Economic Sentiment Indicator (ESI). A desciption of the indicator is as follows:


The Dow Jones Economic Sentiment Indicator aims to gauge the health of the U.S. economy by weighing the balance of sentiment in articles published by 15 major American newspapers.

This is a great indicator because it measures newspaper media sentiment towards the economy which tends to be lagging or coincident. The next best source of "dumb money" sentiment aside from the little guy on main street is the media. Here's a historical chart of ESI. The current reading is actually 46 (not updated on the graph)

So, you can see that based upon historical readings optimism about the economy, although improving is still low with plenty of room to improve before becoming "too bullish" on a LT basis. I also love this indicator because I'm sure hardly anyone knows about it and so it makes it more reliable.


So, based upon what I discussed in this post, can you still say "bullishness is just as high as it was at the 2007 peak" like so many bearish pundits are pointing out. Again, sentiment indicators like Investor's Intelligence which these bears are pointing out don't necessarily reflect LT sentiment conditions, they reflect the views of fickle market timers/advisors who have a ST focus. And as I said before it's also common to see bullish sentiment "thrusts" early in a recovery when evidence starts becoming more and more obvious that the recession is indeed over.


If you look at the start of 1984, 1992 and 2004, all of which were early recovery years, Investor's Intelligence survey's and such were also showing extreme bullish sentiment just like now. It seems that nobody except for me is pointing this out. What ended up eventually happening after sentiment became so called "too bullish" early in a recovery was a multi-month consolidation phase working off this bullish sentiment. They can be quite scary and prolonged making even the most staunchest of bulls sweat. Take for example what happened last summer.


Take a look at what happened in 1984, 1992 and 2004 when there was "too much bullishness" in the sentiment surveys to start off the year.


1984

1992

2004

So, as you can see, in all 3 charts above, the market went through a downward titling consolidation phase which I'm sure made bulls sweat and bears foam at the mouth but in the end the bulls prevailed and prevailed big because the bull market was far from over.


I think we are going to see something similar happen this year as we saw in above 3 charts. In the near future we are probably going to enter some sort of multi-month consolidation phase which will make bulls sweat while making the bears foam at the mouth but by the end of the year the bulls will have prevailed given everything I talked about earlier on. This was similar to what I expected last year at this time as well. Now, just like last year, trying to profit off of corrections in bull markets is difficult and should be avoided. In bull markets you don't go short you go long....either stocks, cash or some combo of the two (Ok fine you can go short to hedge some longs but never go net short or even come close to it).


So what should one do given this outlook? Well, I believe in such an scenario stock picking will be very important. If you can find those winners that have a lot of things going from them company specific wise and you plan to be a long term holder then I would still buy them or at least get a 50% position. I have found that in such cases these types of stocks can ignore ST adverse fluctuations of the general market when the primary trend is still bullish long term. For example when I bought bev.to in September of 2009 that stock traded completely on it's own accord until I sold it in March of 2010 (and it still trades on it's own accord).


The time to get aggressive will be when the current "excessive bullishness" from ST trader types unwinds and hits the opposite extreme. It will require patience however...you might have to wait until the summer or the fall!
It has required courage to be a bull these past couple years and I still feel it requires courage...somewhat of a leap of faith if you will and that tells me it's the right path to be on LT.