Thursday, April 3, 2014

Is a correction close at hand?

About every two weeks I pour through several valuation metrics on the sectors, styles and regions that our clients hold in their equity portfolios. As I've been reporting of late, I see reasonable (not cheap like a year ago) valuations overall. With of course some areas looking more attractive than others.

I also track a number of other indicators, one being the American Association of Individual Investors' (AAII) sentiment survey. And while I'll take the can't-time-the-market mantra to my grave, if I were a market-timer, overall sentiment would be near the top of my list of key actionable indicators.

On January 15th of this year I offered the good and the bad on the "current state of equity markets". One of the bad happened to be "very high bullishness". I got that from the 55% bullish reading (that's a very high reading) from the AAII survey. Then, just a few days later, I reported that bullishness had declined to 39%---and reported that as "good news for the stock market". So, can we blame high optimism going into January as the reason for the ensuing sell-off, and credit the waning attitudes as January unfolded with February's snap-back rally? I wish I knew...

This afternoon I listened to thoughtful analyst Ron Insana predict that a 10-20% correction could be close at hand. Of course I entirely agree: Meaning, for any one, or more, of uncountable reasons, a 10-20% correction could always be close at hand. The thing is, as I listened to Ron making his case, I was thinking about the sentiment numbers, which I had just grabbed yesterday (they were updated at AAII on 3/26), showing bullish sentiment had dropped from 41.3% all the way down to 31.2% over the course of two weeks. I guess I can say I'm more doubtful---in terms of the bottom end of his range (20%)---of a major decline occurring in the very near future than I would be if sentiment were on the rise.

If you're new to this blog, and not a student of markets, you might be wondering why high bullishness would be a negative indicator. You'd think that bullishness means folks are buying stocks, and if folks are buying stocks the stock market is going up. But the thing is, high bullishness readings actually suggest that folks have already bought, thus leaving fewer incremental buyers out there to keep the market moving higher. A little bad news in that environment can go a long way in terms of market declines.

All that said, could we see that way overdue correction (which [overdue] is Ron's main point) occur amid waning optimism? Absolutely. Like I suggested, uncountable are the factors that can move markets. It's just that, as I suggested the other day, if the inevitable big one (20%+) is to occur anytime soon, it will not have been preceded by exuberance (or euphoria). A correction, on the shallower end of Ron's range, would be, historically speaking, more likely in the cards given today's sentiment reading.

Of course things (uncountable things) can change in a hurry. Case in point: I just went back to the AAII survey and found that it's been updated since yesterday afternoon. Bullishness, over the past week, has moved up to 35%. Which is still below its 39% long-term average, but a bearish move up (in terms of what it implies) nonetheless...

Good thing you don't concern yourself with such minutia. Good thing you're a long-term investor who understands that all things are cyclical, that no one can consistently time the ups and downs, that a diversified portfolio is essential to investment success (and personal sanity), and who looks to enjoy—for years and years to come—the goods and services provided by the global companies whose stocks occupy that all-important long-term, growth-oriented, portion of your portfolio…


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