Market Bullishness Reaches Extreme Levels: Are Investors Ignoring Warning Signs?
Lance Roberts | Aug 01, 2023 06:55AM ET
“Bullish measures are getting really bullish.”
This is an interesting statement, given how “bearish” sentiment was in 2022. As I noted then:
“Investor sentiment has become so bearish that it’s bullish.
One of the hardest things to do is go “against” the prevailing bias regarding investing. Such is known as contrarian investing. One of the most famous contrarian investors is Howard Marks, who once stated:
“Resisting – and thereby achieving success as a contrarian – isn’t easy. Things combine to make it difficult; including natural herd tendencies and the pain imposed by being out of step, particularly when momentum invariably makes pro-cyclical actions look correct for a while.
Given the uncertain nature of the future, and thus the difficulty of being confident your position is the right one – especially as price moves against you – it’s challenging to be a lonely contrarian.”
Here is that article’s composite index of retail and professional investor sentiment to visualize just how negative sentiment was then. You will note that sentiment was pushing levels of bearishness not seen since the 2008 “Financial Crisis.”
Looking back, it is pretty evident such was the case, particularly with the QQQ believed to be dead.
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Of course, hindsight is always 20/20. Last year there were many reasons to be bearish. Things were seemingly so bad, with everyone expecting a recession, that there was nowhere to go but up. Since October, market participants have been betting on avoiding a recession. Such has led to a sharp reversal in bearish sentiment as the “Fear Of Missing Out,” or FOMO, kicked in.
Since the end of January, despite the Fed hiking rates, a bank solvency crisis, and weakening economic data, the market has continued to “climb a wall of worry.” In fact, not only did it climb a wall of worry.
The shift from bearish to bullish sentiment has been steady since the beginning of March. The capitulation of bearish investors continues to push markets higher. Retail and professional investors’ “Net Bullish Ratio,” tells the tale.
As a contrarian investor, excesses get built by everyone on the same side of the trade. Previously, everyone was so bearish that the bullish trade higher was inevitable. Today, it is the opposite.
Regardless of your personal views, the bull market that started in October remains intact. However, given the more extreme levels of optimism in the short-term, plenty of evidence suggests a near-term correction is likely. The technically overbought conditions of the market confirm the same.
However, such does not mean selling everything and going to cash.
What I am suggesting is that when “sell signals” are given, individuals should perform some essential portfolio risk management such as:
- Trim back winning positions to original portfolio weights: Investment Rule: Let Winners Run
- Sell positions that are not working (Positions not working in a rising market won’t work in a declining market.) Investment Rule: Cut Losers Short
- Hold the cash raised from these activities until the next buying opportunity occurs. Investment Rule: Buy Low
There is minimal risk in “risk management.” In the long term, the results of avoiding periods of severe capital loss will outweigh missed short-term gains. While I agree you can not “time the markets,” you can “manage risk” to improve long-term outcomes.
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