Sell Dow 12,000

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"I'm
not sure I want popular opinion on my side — I've noticed those
with the most opinions often have the fewest facts."

~
Bethania McKenstry

Opinions are
like noses: everyone has one. But a strange thing happened on the
way to Dow 12,000 — the overwhelming majority of financial pundits
sound like a broken record:

“I think
we should put on another 100 points in the S&P 500 by next
February and another 1000 points on the Dow.”

~
Peter Canelo, Canelo & Associates, 10/13/06

“Our feeling
is that the economy is slowing and this is good news for investors.”

~
Abby Cohen, Goldman Sachs, 10/17/06

"The
upside still outweighs the downside in our view… People forget
— this isn't like the late 1990s. This is like the mid-1990s."

~
Tony Dwyer, FTN Midwest Securities, 10/18/06

“I don’t
think the economy’s ‘landing.’ I think the economy’s doing great…
It’s better than Goldilocks quite honestly. This is the greatest
global boom of all time.”

~
Ed Yardeni, Oak Investments, 10/18/06

“Count
me somewhere between bullish and very bullish. The U.S. stock
market remains undervalued, in my opinion."

~
Bill Miller, Legg Mason, 10/21/06

"It
simply is not remarked upon enough how unbelievably powerful,
how unbelievably bullish this rally is."

~
James Cramer, CNBC's "Mad Money," 10/27/06

Optimism
is pervasive on Wall Street, yet some bulls, well aware of the laws
of contrary opinion, claim too much pessimism as a reason
to own stocks:

“The fact
is we can’t find enough to worry about, and that’s usually a good
time to find value in the stock market… Any red ink between now
and the end of the year is an opportunity and not something for
investors to run from.”

~
Mike Williams, Tocqueville Asset Management, 10/13/06

"…
I think bravado and optimism begets bad times and chronic cautiousness
paints a beautiful picture for the future. [This] is a low-risk,
high-return situation created by cautious players."

~
James Paulsen, Wells Capital Management, 10/20/06

"Could
we have a big bear market? I don't think so. Bear markets come
from a combination of positive sentiment with bad surprises virtually
no one anticipates… Today too many gloomsters and not that many
big-time boomsters (like me) are around for this combination to
occur."

~
Kenneth L. Fisher, Fisher Investments, 10/30/06

The bulls can't
possibly be running confidently and running scared at the same time.
What are the "facts" regarding investor sentiment?

  • Guest commentary
    on CNBC (a.k.a. "Bubblevision") is universally upbeat,
    bordering on giddy.
  • Over the
    last 420 weeks the Investors Intelligence poll of investment newsletter
    editors has recorded more bears than bulls just 6 times.
  • The Hulbert
    Stock Newsletter Sentiment Index shows its sampling of short-term
    market timers with a 67.0% exposure to the stock market. According
    to Mark Hulbert, "the HSNSI’s average reading since the bull
    market began on Oct. 9, 2002, has been just 29.5%, or less than
    half the current sentiment reading. In other words, the wall of
    worry that has on average existed during this more than four-year
    bull market has now evaporated."
  • Institutional
    investors have not deviated from their fully invested course.
    Mutual fund cash levels remain at a paltry 4.3%.
  • Short sellers
    are nearly extinct. An estimated $4 billion resides in bear fund
    assets against $5.5 trillion in stock fund assets. The
    Strunk Short Index used to follow 25 short bias hedge funds; that
    number has dwindled to 8 or 9 (there were over 9,200 hedge funds
    at last count).
  • In a twist
    of irony, many in the bear camp have resigned themselves to owning
    stocks (primarily energy and commodity-related) as a hedge against
    hyperinflation.
  • The investing
    public is all in. Equities account for 35.6% of household financial
    assets compared to the long-term average of 26.5% (since 1952).
    Money market fund balances are near an all-time low 21.3% of mutual
    fund assets (see graph).

Ten of our
favorite sentiment indicators are, on average, in the 73rd
percentile of bullishness versus readings over the past ten years
(see table). Overall, 1996 to 2006 was a period of stock market
ebullience, making the current level of enthusiasm all the more
extreme.

Sentiment
Indicator Percentiles (data sample 1996–2006)

Sentiment
Indicator

Current
Reading

Bullish
Extreme

Bearish
Extreme

Bullishness
Percentile

Investors
Intelligence,
Bulls — Bears

+25.3%

+44.1%

–14.8%

66th

Market
Vane,
Bulls

73%

80%

17%

99th

CBOE
Volatility
Index (VIX)

10.80

10.27

43.74

99th

MMF
/ Mutual
Fund + ETF Assets

21.3%

20.6%

35.3%

99th

Equity
Mutual
Fund Cash Levels

4.3%

3.8%

7.4%

74th

Initial
Public Offerings

2.6

16.0

0.1

37th

NYSE
Insider Buys/
Total Transactions

19.5%

12.6%

68.5%

81st

Speculative
OTC
Volume

4.3%

13.0%

0.8%

44th

S&P
500 Speculative Position

96,700
contracts long

118,100
contracts long

37,400
contracts short

63rd

Call
Option
Complacency

44.4%

32.9%

83.8%

66th

Meanwhile,
the Soft Landing crowd continues to turn a blind eye to a credit
bubble about to go into an uncontrolled spin. Median existing home
prices dropped 2.5% year-over-year, their worst showing in nearly
four decades. Foreclosures in California have doubled in the past
year and are up tenfold in Boston since 2004. Default rates on subprime
loans were 7.35% in July from 5.51% a year earlier, according to
Friedman Billings Ramsey. Michael Perry, CEO of Indymac Bank (one
of the nation's largest home lenders), thinks 4% of America’s mortgaged
homeowners might lose their homes to foreclosure in coming months,
four times worse than the historical average. Subprime lender Accredited
Home Lending, Washington Mutual (with a large exposure to subprime)
and mortgage insurer Radian Group all witnessed sharp stock drops
on disappointing 3rd quarter earnings releases. Since
this rally began in mid-July, the Philadelphia Bank Index (BKX)
looks exhausted, capturing just 54% of the gain of the S&P 500.

Never
confuse a stampeding herd with the facts. Only in a bubble can the
majority — utterly intolerant of dissent — delude itself into believing
it is in the dissenting minority. We're not sure whether such behavior
is disingenuous or simply dysfunctional. Perhaps the old saw applies:
"When everyone is thinking alike, no one is really thinking."

November
4, 2006

Kevin
Duffy [send him mail]
is a principal of Bearing Asset Management.

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