On Friday, we acknowledged the idea that, according to the bear camp, the U.S. stock market is overbought, overvalued, over owned, and over exuberant. We reviewed the argument that stock market sentiment has indeed become a bit "over exuberant" and that our furry friends might just have a point at the present time.
In short, all of the sentiment indicators that we follow are either flashing red lights or, at the very least, waving warning flags at the present time. And while such indicators are not in and of themselves, bull market killers, they do suggest that it might be time to take one's foot off the gas a bit.
Today, we will continue to explore the bear argument and will look at the idea that stocks are over owned at this point in time.
The Public Is Back In The Stock Market
While there is little evidence that the much ballyhooed "great rotation" (out of bonds and into stocks) has occurred, it is quite clear that the public is indeed returning to the stock market.
After having their heads handed to them via losses of more than 50 percent during both the tech bubble and the credit crisis bear markets, it is little wonder that the public pulled money out of the stock market continuously from 2009 through 2012. However, in 2013 that trend changed.
According to fund flow data, the public has been investing in stock funds at a pace not seen since early 2000. Apparently all the talk about new all-time highs in the stock market indices, an improving economy, and the lack of a new crisis has convinced John and Jane Q. Public to get back into the game. Well, that and a four and one-half year-old bull market that has produced gains of 170 percent, that is.
If the Public Is Buying...
Many market analysts view the fact that the public is buying stocks again as a clear negative. The thinking is that the public tends to jump on the bull train late in the game, only to bail out whenever things get ugly. From a strategy standpoint, this would appear to be a case of buying high and selling low. Not good.
However, it is important to recognize that bull markets tend to last longer and move farther than most investors can imagine. Hence the phrase, "Markets can remain irrational longer than you can stay solvent."
Remember, a great many bull markets experience what is called a "blow off" top. This is a time when the stock market is great fun and where making money in the stock market is viewed as a no-brainer by the public. For the record, this is also the time when a great many bears give in and capitulate to the pain of missing out. In short, the public's mood becomes celebratory in nature.
The Public Is Right During the Middle, But...
It is this tendency for things in the stock market to get ridiculous on the upside BEFORE the market ultimately reverses that gives the public a bad rap. But, if one studies the flow of money into/out of mutual funds, it becomes clear that the public is actually right during the middle of bull markets. It's just that they also tend to wrong at both ends of the big moves.
But this can be said of mutual fund and even the majority of hedge fund managers as well. For example, it was recently reported that hedge funds are curtailing their "hedged" positions at a record pace in order to try and capture more of the stock market's upside. Oh, and the introduction of long-only two-and-twenty funds is also a hot trend as well as a sign that the hedgies may not be great timers of the market either.
Any Signs of Speculation?
So far at least, the evidence provided has been entirely anecdotal. However, some recent data from the Federal Reserve Board shows that there may be some signs of speculation developing amongst the public.
As of September 30, 2013, the Federal Reserve reports that U.S. households have $17.3 trillion in equity holdings. And as a percentage of their overall household holdings, stocks represent 38.7 percent.
So, how does the public's current level of stock holdings compare to times past, you ask? From 1952 through 1996, the high water mark for the public's level of equity exposure was 38 percent. But then, as you might imagine, exposure levels soared in the late 1990's, hitting a peak of 53.1 percent in the first quarter of 2000. If you will recall, this was a time when everyone was in stocks and soccer Moms spent most of their day in front of the computer day-trading internet stocks!
Not surprisingly, that level of equity exposure was bubblesque, as the percentage of stocks owned by households dove from 53.1 percent to just 31 percent by 2003.
However, by 2007 the public had regained their confidence and the percentage of equity ownership by U.S. households had moved back up to 40.9 percent. This move would seem to indicate that some investors must have been buying the darn dip. As such, it appears that contrary to popular belief, not all public investors are mo-mo bull market bandwagon oriented.
Of course, the measure of the public's stock holdings then plunged to 24 percent in 2009 as the credit crisis took its toll on the collective psyches of investors. So, one could also argue that some investors may have exited the stock market before the S&P lost 55%!
The Bottom Line
There would appear to be two primary takeaways from this data. First, at 38.7%, the public's holdings of equities relative to their entire holdings has now risen to the third highest peak on record and is up from 24 percent just four years ago.
The second takeaway is that the current level of equity exposure among the public can certainly go higher. This would be especially true if stocks were to enter into a "blow off" stage.
The bottom line is stock market investors should now be on the lookout for any and all signs of speculation. While stocks can move higher, moves that become over exuberant tend to end badly.
This is not to suggest that stocks will continue to romp or soon succumb to a meaningful decline. However, neither event would be terribly surprising in the coming months. Thus, it's time to look alive out there and avoid becoming complacent.
Positions in stocks mentioned: none
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