Sentiment: Not Yet Good Enough To Be Bad

Stock market sentiment has certainly heated up in response to the tax hike (...wait until those first paychecks arrive), but investor optimism is still a good distance away from the levels seen at the interim peaks of April 2010, April 2011 and April 2012.

  • We’re eager to see whether the public begins tiptoeing back into stocks now that the S&P 500 has printed a new high and a band-aid solution to the deficit has been reached. And, perversely, valuations should now be high enough to get the public interested in stocks. Since 1980, months of net inflows into U.S.-focused equity funds have occurred at an average Normalized P/E of 20x—exactly where the S&P 500 stands today. (Net outflow months occur with P/E ratios 3-4 points lower than this.) Remember, though, stocks can go up without public buying pressure… witness 2012.
  • Contrarians should note many of our sentiment measures show considerably less optimism than in early 2010, when the S&P 500 was more than 300 points lower than today. For example, the CBOE Equity Put/Call Ratio has tended to show less enthusiasm (i.e., lower call buying) at each successive intermediate-term market peak since April 2010. Interestingly enough, a nearly identical pattern played out during the 2002-07 bull market, with the Put/Call Ratio recording peak optimism in January 2004—almost four years before the eventual bull market high.
  • One certainly shouldn’t expect the options data or any other sentiment measure to “ring a bell” at the final bull market peak. Don’t expect the loony atmosphere of 1999-2000 to reappear. I expect the top to be fairly subdued. An historical analog might be the market top of November 1980, which represented the only month of sizable mutual fund inflows for that entire 2 1/2 year bull market.

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