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.