Sour grapes and Sentiment

I've noticed a lot of articles lately warning about how the market is showing bubble characteristics and may be near its end. A common observation to support this view is the large inflows into equities this year and since retail is always late to the party, it signals a bull market peak is immanent. Trimtabs reported that this year has shown the largest inflows into equities since 2000 and so this must have ominous implications. I will argue that these worries are premature and it seems so many of the top callers out there have sour grapes for missing the bull market.

I clearly remember the bearishly inclined pointing out a couple years back how the market was rising without the participation of retail investors which meant that the bull market was "phony"and not sustainable. I argued just the opposite - that this was very bullish for the market given that bull markets don't end until retail has fully embraced it. Now that we are seeing retail get back into the market the doomers  argue that retail are sheep.  So, according to them it was bearish when retail wasn't participating and it's now bearish that they are! Lol! So pathetic. You know what doomers? Just shut the fuck up already and be humble for once.

Anyhow, back to the strong inflow situation. The inflows we have seen this year large as it may be,  is following 4-5 years of heavy OUTFLOWS and so this by no means suggests retail has fully embraced the bull market. It shows instead budding optimism after several years of deep pessimism. It is perfectly normal to see a bull market accompanied by optimism and hence strong inflows for years prior to its peak. That's what happened all throughout the 1990's bull market and the 2003-2007 bull market. But this has been no normal bull market.  I have often referred to the situation as bizzaro world because the wounds from 2008 cut so deep. This is why it took so long for retail to get back into the market. Are they late to the party? We will see. I suspect there are some Johnny come latelys and a shakeout is forthcoming but history shows that 1 year's worth of inflows does not suggest an immanent bull market peak, especially when there was 5 years of outflows prior to it.

Assessing sentiment is more of art than a science. You have what I like to call "ST sentiment" which is relevant to the outlook for the next 1-4 months  and "LT sentiment" which is relevant to the LT trend of the market i.e. whether it's in bull or bear mode.  A good way to think about it is like this: ST sentiment is the equivalent to the position of the earth's daily rotation and LT sentiment is like the position of the earth's orbit around the sun. Indicators I often mention such as AAII sentiment and weekly fund flows are ST sentiment indicators. Often times I see people incorrectly using these type of ST sentiment indicators to gauge the LT condition of the market. Currently the ST sentiment indicators which includes the recent surge in inflow the doomers are griping about is signaling there is over-exuberance that makes the market vulnerable in the ST but not the LT. And like I said last post, it's possible for a market in bull mode to still make significant headway when ST sentiment is redlining like this (but when the correction does come it wipes out all those gains made) which is why timing ST tops in bull markets is often very difficult.

The following chart is what I believe, an accurate picture of what LT sentiment looks like right now. It shows investor's  "risk appetite". I love this indicator not only because of its great track record and that it's under the radar, but also because it takes into account 46 economic inputs.

As you can see, we are just edging into the risk seeking  phase i.e. optimism phase of the bull market. As you can also see, in prior bull markets, risk appetite was well in the risk seeking part of the chart for years until the bull market peaked which at that point investors became risk loving (greedy) along with a tight money (inverted yield curve) situation -  the lethal combination that kills bull markets.

There are some pockets of froth out there such as some of the internet and social media stocks but overall, the above chart shows we are still comfortably far from the point where investors are greedy on a  LT basis. This is also confirmed by the anecdotes I always mention. What's also notable about this chart is how extremely risk adverse investors were at the nadir of the financial crisis. It shows that went through a once in a century type storm and we are simply just starting to normalize.  But I must warn as I always do that these types of indicators are not ST market timing tools. I would have (and did)  made the same LT bullish case in mid 2011 just prior to the 20% drop in the market.

Keep your guard up

So much for the "sell in May and go away" strategy. I've never been a big fan of seasonality. At best, I will consider it a supporting indicator if it's giving the same message as the more important indicators I track. So, according to seasonality studies, the next 6 months are the favorable months to be invested in the market. Again, I will not hang my hat on such a view whatsoever. Right now, the ST sentiment backrop for the market is not good. The Rydex ratio, NAAIM, AAII and fund flows are all suggesting that there's too much ST exuberance in the market.There have been a few times in this bull market and in the bull market of 2003-2007 where ST sentiment gets this frothy but stays frothy for several more weeks with the market chugging higher, but when that did happen the correction that followed wiped out all those gains and then some. Bottom line here is that it's time to ring in the register and lighten up and/or put on some hedges. I've chosen to do the former for now.

I've lightened up significantly on my position with hwo.to for a few reasons aside from ST market concerns. The stock got a nice boost a couple weeks ago when a popular CDN  fund manager named Jason Donville spoke favorably about the company on BNN. This was the first time any so called "guru" mentioned hwo in years. Although the company continues to hum along well with its business making a healthy amount of profit, they are likely not going to show any growth vs last year. Although only 30-35% of  revenues are in Canada, its still gets under the pull of the CDN O&G service sector in general and according to my trusted source (a former CEO of a CDN service company) Q3 earnings for the service sector is poised to once again show a y-o-y decline in Q3. This sector has shown considerable weakness in earnings/cashflows this year which has made hwo's "flat growth" look stellar, but despite weak earnings most of the stocks in the sector have managed to post respectable gains so far YTD because of high hopes of the LNG related drilling that is expected to take place in Q4 and Q1. I'm not willing to take such a leap of faith with the stocks up on the year like this. If we see yet another weak quarter of earnings for the sector and the market in general gets under pressure, I don't see how people will look at the service sector as some sort of safe haven, if anything, it could get hit the hardest and so with hwo getting a well timed pump from Donville, I just had to ring the register given my heavy exposure and all the aforementioned concerns. It's a tough call because the stock is by no means fully valued; it can still very well go significantly higher if they announce some good news like an acquisition or new contract, but the stock is no longer the screaming bargain it was a year ago and it has a history of being very volatile and I doubt most of these "Donville buyers" are true believers of the company and therefore are not strong holders.

Greenstar has been drifting lower for the past month and I'm not surprised given what I believe is a supply overhang as I discussed in a recent post. There is no news or other fundamental issues to account for the weakness. Unlike with hwo, my conviction level for GRE remains very strong even with my ST concern about the market. At this silly valuation and given the outlook for GRE's earnings in the coming quarters, I know that time is on my side. The stock could very well continue to go lower in the ST, but simple mathematics indicate that the current price is unsustainable in the LT. Will I be annoyed, frustrated and start having paranoid concerns in the back of mind if the stock continues to slide? Of course, but that's the price you have to pay when you have a "pot committed" position. In the meantime though, I will collect a generous dividend.