Category: market strategists

Bullish rationalizations from a Wall Street market strategist

'Bear Market Checklist' Goes a Perfect 0-for-6

According to CNBC staff writer Jeff Cox, Morgan Stanley chief investment strategist David Darst is “a realist – cautious but not cowering, optimistic but not overzealous.”  Says Darst:

“The market’s running.  When cookies are passed, grab the cookies and realize they may not come back around again, and it’s not always going to be thus…  Nobody is buying stocks, and they will someday.  There will be a coil-spring reaction.”

Apparently, such commentary passes for restraint these days.  Further, Darst maintains a bear market checklist:

  1. Is the Federal Reserve tightening monetary policy?
  2. Are stock price valuations stretched?
  3. Is investor euphoria present?
  4. Are bond spreads widening?
  5. Is there a recession looming?
  6. Are transportation stocks, small caps and bank stocks retreating?

“Right now we are 0-for-6 in the bear market checklist.”

In addition to the ubiquitous complacency after a 4-year 140% rise in stock prices, what caught our eye is rationale #3 to which Cox added his own journalistic license:

“In spite of the seemingly easy path to more gains for the stock market, which is up the more than 20 percent from its last low required for a technical bull market, there is still plenty of fear in the market…  This year has seen the first consistent inflows in stock-based mutual funds since the financial crisis began, but investors are still cautious and pouring just as much cash into bond funds.”

Fear?  Let’s go down our abridged investor sentiment checklist:

  1. Rydex bear fund assets: 16.9% of bull + bear fund assets (93rd percentile of bullishness)
  2. Rydex money market fund assets:  19.9% of bull + sector fund assets (97th percentile)
  3. 3-month VIX contract: 16.45 (80th percentile)
  4. Equity fund cash levels: 3.7% (73rd percentile)
  5. MMF assets: 17.2% of mutual fund + ETF assets (record low, 99th percentile)
  6. Investors Intelligence poll: 19.8% bears (87th percentile)

Incidentally, I am not just cherry picking statistics to make my case.  These all have proven long term track records as contrary indicators.  Such an analysis is admittedly quantitative and never perfect.  For a qualitative view on sentiment, simply turn on CNBC.  95% of the pundits are bullish, many of whom justify their optimism because they sense “fear” amongst investors.  This is quite delusional behavior, classic of manias – what I refer to as the “double contrary.”

Wall Street’s strategists still bullish

According to an article in the September 1 issue of Barron’s, Wall Street’s market strategists are notably more “conservative” in their outlook:

A discernible chill has crept into Wall Street’s autumn outlook, along with a readier acknowledgment of the economic peril ahead. No more premature articulation of a year-end rally. No gushing about stocks’ potential. Among the nine strategists or chief investment officers surveyed by Barron’s, the average forecast calls for the Standard & Poor’s 500 to end the year at 1363, a mere 5% higher than Thursday’s close at 1301. A tenth strategist, Richard Bernstein of Merrill Lynch, has no year-end target but sees the 500-stock benchmark at a very modest 1381 a year later.

The conservative tack is unusual for this vocationally bullish bunch, who could easily have accentuated the positives — Hospitable interest rates! An obliging central bank! Dire investor sentiment! — to call for a rollicking fourth-quarter rebound. But as home prices have continued to slip and credit constricts, strategists, like many investors, have spent the summer nudging down their estimates and postponing their expectation for economic revival.

Yet on closer inspection, these strategists look downright bullish. While the mean forecast of 1363 calls for a 4.8% gain in the S&P 500 by year-end, the median forecast of 1400 calls for a gain of 7.6%. Last year, the median target was 11.9% above the previous Friday close and 13.2% above the previous Thursday close, but this was over a 12 month period. (We blogged about it at the time here.) Annualizing the collective 4-month forecast of 7.6% – admittedly a stretch – yields a 12-month prediction of +24.7%, quite bullish indeed.

Favorite sector? Technology, which won over 7 of the 10 strategists.

My comment: At best, over the past year the Slope of Hope has been downgraded from double-black to single-black diamond. Proceed at your peril.

Barron’s on strategists: Few bears here

Over the weekend, Barron’s took the pulse of 8 top Wall Street market strategists. Despite the recent credit pounding, they remain indefatigable, even upbeat:

It might be reassuring to some — and surprising to others — to hear how Wall Street’s top strategists calmly expect stocks to finish the year higher. In fact, the eight strategists surveyed by Barron’s see stocks climbing well into 2008, despite the credit-market tumult and the policy uncertainty of the election year.

The average forecast among the eight calls for the S&P 500 to reach 1568 by New Year’s Eve, or 6.4% higher than today’s level of 1474, and even the most cautious have penciled in hardly any downside for stocks. In contrast, their economic prognosis is far less assured and unanimous: Three firms see economic threats grave enough to require the Federal Reserve to slash interest rates to 4.5%, from 5.25% today, while two others think the economy is doing just fine.

The strategists’ bullish tilt is especially remarkable considering how many believe the financial markets have altered for good, with the days of easy money and cheap debt fading like the summer heat. “We’ve been through a long period of extraordinarily easy credit, and there’s no putting that genie back into that bottle,” says Tom McManus, Banc of America Securities’ chief investment strategist.

Their primary reason for optimism? The ongoing strength of the global economic boom with an assist from an accomodative Fed:

So what drives their sanguine stock outlook? The strategists expect U.S. profit growth to accelerate, driven by the engine of a global economic boom. All are counting on interest rates staying meekly cooperative.

As a result, they’ve piled into the same sectors expected to benefit – energy, materials, industrials, and information technology:

“Yes, some of these trades may be crowded,” says Goldman’s [Abby Joseph] Cohen of the preference for large-cap stocks and global exposure. “But it’s still worthwhile if its price-to-earnings or price-to-book valuations are still attractive. The consensus is not always wrong.”

The tired platitudes of the bull case are well represented.

a) Balance sheets are strong and liquidity in ample supply:

“People also equate the credit crunch with a liquidity crunch, and that’s wrong,” [ISI Group’s Francois] Trahan says. Among other things, cash on corporate balance sheets is high, at nearly 15% of the stock market’s total valuation, and the influx of petro-dollars and global money-supply growth all make for abundant liquidity. Trahan stands by his year-end S&P 500 target of 1700, which he set this spring.

b) Valuations are reasonable:

Downside stock risk is further limited by stocks’ moderate valuation, the strategists say. The S&P 500 is trading at 15.9 times its operating earnings over the past four quarters — within the valuation “bull’s eye” of between 14 and 16 times, notes Citigroup’s Tobias Levkovich. Since 1940, a price-to-earnings in that range has produced strong returns averaging 17% in the next 12 months.

And c) The proverbial Wall of Worry is intact:

AUGUST’S JITTERY STOCK slide also was seen as a contrarian Buy signal. “Investors are very nervous right now, and embedded risk premium is higher than warranted,” says Goldman Sachs’ Cohen. “The stock market is undervalued relative to its fundamentals.” In addition, corporations’ balance sheets are in “excellent shape,” with enough liquidity to finance new jobs, strategic acquisitions and business expansion.

My comments:

  1. The median 12-month forecast for the S&P 500 is 1650, 11.9% above current levels. This appears to be about normal for 12-month targets the past 10 years, a time of overall optimism.
  2. Wall Street remains a web of contradictions. Strategists are uniformly bullish, yet believe a wall of worry exists. Corporate balance sheets are solid, despite Wall Street’s largely successful attempts to lever them up. They argue corporate profits will remain strong, even though the main driver of those profits – easy credit the past 5 years – is going away. The global economy is expected to carry the day, powered by none other than “global liquidity.” Yet this same liquidity – at the domestic level – was the main plank in the bull case, that is until it recently dried up.
  3. Bullishness remains, though the rationales change with the weather.

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