Maybe I am over thinking this: The sentiment picture seems just a little too neatly packaged to me and it would be just a little too easy to be overly bearish here. Positive flows into equity funds after a long winter of negative flows could be interpreted as positively as the return of bullish momentum. Indeed, Schaeffer's Research reported enormous buying of VIX calls last week as a bet on rising volatility (and falling markets), which is contrarian bullish. I heard several talking heads on CNBC late last week cited the same kinds of reasons to be bearish from a sentiment viewpoint.The financial crisis is over!
While I understand that sentiment models, on an intermediate to longer term time horizon, can give a bearish picture, but is too much trader bearishness supportive of the markets here?
Fast forward to today, it seems that while the sentiment model readings remain largely unchanged (still overbullish), the tone of the commentary has turned universally bullish. As an example of this sentiment shift, Bloomberg reports that the latest consensus out of Davos is "the financial crisis is over":
The hive mind of Davos has concluded that the financial crisis is done, finished. The new worry: a bubble in the credit markets.BoA/Merrill Lynch is trumpeting its "Great Rotation" into equities investment theme:
There is no official declaration, or even a formal survey. But the chatter at the World Economic Forum in Davos, Switzerland, is about the end of the financial crisis that began in 2008 and dragged on through last summer’s spike in Spanish and Italian government bond yields. “There’s a crystallization of thought that the financial crisis is over,” says Scott Minerd, managing partner and chief investment officer of Guggenheim Partners, a Santa Monica (Calif.) firm with about $160 billion under management.
The beginning stages of a great rotation in the markets create opportunities for cyclical and undervalued asset classes poised for recovery.Soros less bearish on Europe
“This time last year, the risks to global growth were to the downside as the European debt crisis, China hard landing fears and the U.S. fiscal cliff clouded the economic outlook,” said Michael Hartnett, chief investment strategist at BofA Merrill Lynch Global Research. “For 2013, we expect the resolution of fiscal policy issues, another year of accommodative central bank actions and improving corporate profits to skew the macro and market risks to the upside.”
Remember how George Soros' endless warnings about Europe and how the European experiment was on the verge of failing? In June 2012, he sounded the alarm that Europe had three months to solve its problems. In this Der Speigel interview, he said that Germany had to take leadership and stop obsessing about austerity as the solution:
With the EU summit set to start on Thursday, pressure is on European leaders to find a way out of the euro crisis. Investor George Soros is pessimistic that a solution will be found and says time is extremely short. In an interview with SPIEGEL ONLINE, he warns that Germany could develop into a hated, imperial power.Today, he has conceded that the euro is here to stay:
George Soros, one of the most outspoken critics of Germany's austerity policies to solve the European debt crisis, said that the euro is here to stay and will gain as other nations seek to devalue their currencies...Dalio bullish
Germany will always do “the minimum” to preserve the currency, Soros said yesterday at the World Economic Forum in Davos, Switzerland. He forecast a “tense” two years for the euro region.
Other well known investors, such as Ray Dalio have turned more bullish (via Business Insider):
Dalio says 2013 is likely to be a transition year, where large amounts of cash will move to stock and all sorts of stuff – goods, services, and financial assets. People will spend more with the cash, they will invest in equities and gold – the cash will move.As much as I would have great respect for investors like Soros and Dalio (and would loathe to be on the other side of a Soros or Dalio trade), the sudden outpouring of bullishness (or in Soros' case, an easing of bearishness) is a short-term red flag for traders.
A Front Page Cover sell signal
I wrote about my nervousness last week (see Too far, too fast) and I reiterate my concerns about the outbreak of excessive bullishness. Barry Ritholz also pointed out that a New York Times front page article entitled As Worries Ebb, Small Investors Propel Markets is a contrarian Front Page Cover sell-signal.
Looking for a bearish trigger
With sentiment at such crowded long readings, we just need a bearish trigger to spark a corrective selloff. As we are in the middle of Earnings Season, any negative surprise could spark a downdraft. My most likely candidate for a negative surprise is the Non-Farm Payroll release on Friday, where Gallup's tracking polls indicate that the employment situation deteriorated in January:
Approaching important relative resistance
Speaking technically, the relative performance chart of SPY (stocks) vs. TLT (US long Treasury bonds) below as a measure of the risk-on/risk-off trade shows the SPY/TLT ratio in a strong rally and approaching an important relative resistance level. The relative resistance level consists of both the previous highs seen in March/April 2012 and a Fibonacci retracement level, which suggests that the risk-on trade has a high probability of stalling soon.
At this point, my base case calls for stocks to correct 5-10%, at which the uptrend continues. However, that scenario is subject to change as circumstances change. We may be nearing an inflection point and will have to take this one day at a time.
Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.
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