Market Strategist Sees Stocks Oversold at Current Levels

Stocks

Bank of America Merrill Lynch’s investor position indicator has turned bearish for the first time since January. That apparently means that stocks are bearish and we should buy.

There are a lot of different indicators that people look at to look to be shown the way as far as where the price of a stock of the price of stocks in general are headed, of various quality, and some of them are considered contrarian indicators, meaning that we want to do the reverse of what the indicator is telling us.

Contrarian indicators are usually aimed at the public, and whatever the public is thinking, we should want to hold the opposite opinion, contrary to the public in other words. In the larger sense, the public here generally means the market.

A good example of a contrarian indicator is when you see a particular market move reach its peak in the media, like seeing bulls or bears on the cover of Time. The thinking is that by the time the man on the street who doesn’t even follow the markets is very well aware of the market direction, we’ve really reached a saturation point and the end may be near.

This does happen at times of course, but this is more of a throwback than anything, at a time where stock market trends used to cycle a lot more, often in concert with bigger swings in the economic cycle.

Investment has changed a lot since the old days though, and the old days aren’t really that long ago, when people used to time their entries more than they do today. Today’s investment strategies are much more systematic, where people just keep contributing to it with their retirement accounts or general investment ones and don’t even pay much attention to what is going on, and are also told that they should not.

When you combine this with the much smoother economic cycle that we are in and are expected to stay in for the foreseeable future, where you have a lot less boom and bust cycles than we used to, this serves to sustain bull markets a lot. If you’re just planning to keep buying over time regardless, and aren’t planning on selling unless a truly bad event happens, a recession for instance, and we don’t get much of that, this is going to change the game.

Since people aren’t really investing in such a variable way anymore, and when we run into troubles such as the trade war with China, this really isn’t going to produce the extended down cycles that we used to see. It used to be that we could get a bear market lasting a decade or two, but nowadays this is limited to a month or a quarter and we don’t even want to call these things major trend reversals, exceeding the threshold that investors generally use.

The contrarian view lives on though in the minds and the memories of others, even though it’s now more like the crowd taking the ball and running with it. Someone has to take it from them these days though and while they may run a few plays that lose yardage, if we use a football analogy, the offense just keeps making first downs and stays on the field rather than all the punting they used to do.

Anytime we see something that is supposed to be a contrarian indicator being touted now, we need to be sufficiently skeptical, and just because it may have worked well since the days when J.P. Morgan himself was in the business doesn’t mean that it still is valid.

This doesn’t mean that we should just throw out these things out of hand, as they still can add weight to the overall picture, it’s just that you can’t just go on this alone and it’s questionable whether this was ever a good idea anyway.

When we’re looking to decide what to do with our stock positions, given that we’re of the sort that is looking to vary our stock market exposure according to risk, which would certainly place us in the minority, we need to look at any information that may be useful, and in some cases contrarian information might be, at least if it is pointed in the direction of the trend.

Seeing the crowd bail on a trend is never a good thing to see though, because prices do move with the crowd, but what we’re actually interested in when looking to project future stock prices is what they are likely to do a little down the road, especially if certain events occur.

It Takes a Lot More to Scare the Market These Days

We don’t really saturate the market like we used to because we really haven’t had any recessionary concerns since the last one, as this is no longer a matter of people having the will as it is the means. If growth turns negative, that means people will not only have less to invest, they will be taking out more than usual to meet the more challenging economic times.

Some can be scared out though but we’ve already seen a genuine bear move in the latter part of 2018 and the sky didn’t fall. Once the market got comfortable enough that interest rates weren’t just going to keep going up, that was enough and we got back what was lost in the fourth quarter of 2018 in the first 4 months of 2019.

Betting on the bulls is what we do with stock investing overall, and stocks have an upward bias overall. This upward bias has accelerated over the decades and is higher now than it ever was. We therefore can invest in stocks relying completely on this positive expectation over time, and as long as our time frame is long enough, we have been right and have been rewarded.

There have been plenty of bumps in the road along the way though, but these bumps in the current century have been limited to situations of particular note, such as the crash in 2000 after the market genuinely got saturated by so much extra money being put in stocks, or the near economic collapse of 2008.

Most people don’t realize how close we came to economic Armageddon back then, and if not for the massive bailouts, in the nick of time, the entire banking system would have collapsed and we would have been thrown into a depression that would have exceeded anything we have ever seen.

These events don’t come around very often though and otherwise, it’s business as usual. We need to therefore be more wary of bearish calls along the way, unless we are really in a situation like these two where a crash is well within the realm of possibilities. It will take a lot to knock the bulls off the ball, and we need to assume they will keep running unless we get some convincing evidence to the contrary.

This does not mean that we won’t have lulls, and the period between January 2018 and August 2019 has not produced any market gains at all for instance, but we’re no further behind either. Given that most people are indeed in it for the long term, they will need a whole lot more than this to even have them backing off very much on the money that they put into the market month after month, and they need even more to not only stop but take a lot of money out.

We May Still Want to Fade the Public, But We Need Be Careful

Michael Harnett of Bank of America Merrill Lynch has shared the results of the bank’s investor position indicator, which has dropped to January 2019 levels, and to him, that means a bearish signal that we should be bullish about. Betting against this signal has produced above average returns since 2000 in the three-month period after the signal, so that is supposed to mean that it is a good time to buy stocks.

In 2019 though, we should actually find this indicator, which measures things like investor settlement, rather troubling rather than exciting, and if anything, this should have us treading more, not less cautiously.

Data like this really needs to be defined more to be useful, as there are different reasons why market sentiment might turn to the negative, such as going through a bear market or just being worried about a bull market coming to an end. Toward the end of bear markets, this is where the big money steps in and brings us back, and this is surely a reason why this indicator has produced the results that it has.

On the other hand, when you are worried about a trend reversal like many are now, that’s a different situation altogether. With bear markets, the damage has already been done and we may be in its final stages, but with a potential reversal, it has not yet begun and what is missing from this instance is the boatloads of money that are anchored in the harbor waiting to land ashore as we see with the bear markets.

Without that, all we have is the mob starting to run, and if they actually do pick up, this is where we need to be concerned. Whether or not this will be a sustained emptying out of the room, watching the direction of the mob won’t be anywhere near as opposed as when we’ve already fallen a lot.

This indicator doesn’t just look at market sentiment though, it also looks at things like the price of treasuries, where rising prices are seen as bearish but the kind we want to fade. In a lot of cases, bonds going up a lot means stocks go down, because of people selling stocks to buy bonds, but we aren’t really seeing much of that now so this hasn’t meant much this time.

Stocks have been pretty range-bound lately even though on the big charts it still looks like a 10 year move up. This has at least slowed down although the air is far from out of the tire yet as we have seen with their performance this year thus far.

This indicator really doesn’t tell us that much though and especially is not a stand-alone recommendation to buy or even hold. Markets are far more complex than this and we need to look at the whole picture to get anywhere close to a good enough idea about what we should be doing.

It’s not so bad to see someone like this give a thumbs up even though it is based to some degree anyway on the public being wrong, to provide some contrast at least with all the bearish and skittish views out there.

While we may wish to cast our binoculars upon the horizon at times, the size of the waves that are hitting our ship are even more important. While we’ve seen the waves get a little bigger than we may like lately, the sea is still far from stormy enough that anyone should consider heading for the life boats, at least the ones that got on expecting to complete the journey and arrive at their longer-term destinations.

Whether we want to be more aggressive here, based upon this indicator or anything else out there that seems to be telling us to do this, is another matter, As long as the waves are this choppy, increasing the speed of our ship may not be the best idea right now even though we may still wish to remain aboard.

Ken Stephens

Chief Editor, MarketReview.com