Stock Market Bulls Getting Too Bullish

3 mins. to read

By John Paul Whitefoot

Whether you’re in Pamplona, Spain or on Wall Street, when it comes to running with the bulls, the object is to stay ahead of the pack. This means not getting gouged physically or financially. However, there are an increasingly large number of investors out there right now who think they’ve got a handle on the bull market.

Why? The Federal Reserve says it won’t taper its generous $85.0-billion-per-month quantitative easing policy until the U.S. economy improves. And by that, it means—for now at least—an unemployment rate of 6.5% and an inflation rate of 2.5%.

As a result, the Federal Reserve’s easy money and artificially deflated near-record low interest rates have put the stock market front and center for income-starved investors looking for capital appreciation. As long as the Fed keeps its printing presses in overdrive, there’s no reason to think that the bull market will take a breather.

Case in point: in spite of a year marred with revised lower earnings in the first, second, and third quarters and a record 83.5% of companies issuing negative guidance for the fourth quarter, investors have been flocking with reckless abandon to the S&P 500, which continues to trade near record levels. (Source: “Earnings Insight,” FactSet web site, October 6, 2013.)

For the last week of October, 45% of investors were bullish on the market, down from 49.2% for the week ended October 24—the highest level since February 2011. Month-over-month, the number of market bulls climbed 25%. Over the same period of time, the S&P 500 climbed 4.8%. In the last week of June, just 30.28% of Americans were bullish, representing a four-month increase of 50%; the S&P 500, on the other hand, increased 9.7%. (Source: “Sentiment Survey,” American Association of Individual Investors web site, last accessed November 7, 2013.)

What about the bears? At the end of October, 24.5% of Americans were bears versus 30.6% at the end of September and 35.2% at the end of June.

The increasing spread between the number of investors who are bulls and bears is significant because, according to the late Sir John Templeton, bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.

But few seem to agree. The CEO and president of one investment firm said the bull market will rage on for another five years because he can feel the exuberance and strong positives in the U.S economy—meaning the stock market will continue to be the best game in town. (Source: Navarro, B.J., “Bull market has 5 years ahead: Pro,” CNBC web site, November 6, 2013.)

It could be argued that as long as the Federal Reserve’s money tree keeps blooming, the bull market will continue to rage on. But history shows that too much optimism is actually a bearish signal rooted in unrealistic expectations.

In fact, the divergence between the number of sky-high bull market investors and basement-dwelling bears, coupled with the stark economic disconnect between the bull market and the weak economic environment (high unemployment, stagnant wages), points to a correction.

What does this mean for investors? For starters, don’t get hypnotized by the bull market’s blind optimism; revisit your retirement portfolio and find out where your strengths and weaknesses lie and rebalance if needed. Eventually, the markets will catch up (or clue in) to what’s actually going on in the U.S.

On the other hand, if you don’t like sitting on the sidelines and want to take advantage of the bull market, you could always consider an exchange-traded fund that tracks the S&P 500 in step or inversely.

This article was originally published at Daily Gains Letter

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