Too Many Bulls to Trust This Rally

01/13/2011 12:53 pm EST

Focus: MARKETS

Kelley Wright

Managing Editor, Investment Quality Trends

Frothy investing sentiment might carry stocks higher still, but soon enough it will be time to play defense, warns Kelley Wright of Investment Quality Trends.

Two things that concern me are complacency and extreme bullishness.

Some pretty famous forecasters are calling for the Standard and Poor’s 500 index to hit all-time highs this year, as are many Wall Street research departments. The Bloomberg consensus has the S&P 500 reaching 1325 by year’s end; the high end of the forecast is S&P 1550. In Barron’s “Outlook 2011” in the Dec. 20 issue, the ten strategists and investment managers surveyed pegged the S&P at 1373. This is on top of the 20% return off last summer’s low and after all the post-Lehman losses have been recovered. Not one bearish or flat forecast; mind-boggling.

It’s not just Wall Street, mind you. The latest weekly survey by the American Association of Individual Investors reads a whopping 63.3% bulls and a very puny 16.4% bears. [Bullish sentiment in the AAIA survey has more recently dipped to 56%—Editor.]

We even see it among some of our own at our sister asset management company, IQ Trends Private Client. When clients start chirping about not being aggressive enough, the worm has definitely turned.

The Fix Is In
Justified or not, the wind is at the back of the market right now; so we don’t want to fight the Fed and we don’t want to fight the tape. You might remember back to last December, however, when there was an equally bullish rally; by August the S&P 500 was in the red and down 14% from its April highs.

Also, all the upward economic growth revisions for the next two quarters remind me of last year as well, when 5% US gross domestic product growth was supposed to be a layup and the Fed would be looking for an exit strategy. Instead, we got more Fed bond purchases, the promise of fiscal responsibility by the new Congress, and a two-year extension of current tax policy. We’ll never know the answer, but the question that is begging to be asked is, without the aforementioned, would we have had any gains at all in 2010?

Just the environment I dream about: extremely bullish sentiment on stocks and equally bearish sentiment on bonds. And by the way, when bond yields and stock prices are going up at the same time, as they are now and did back in 2007, the history isn’t too kind. Thers's typically a reversal in both markets.

$100 Oil on the Boil
The way I see it is the first quarter will probably be good; maybe the second quarter, too. [Back in November, Wright knew the year-end would be good—Editor.] The Fed’s bond-buying program comes to a close at the end of June, and by then we’ll know if the “boost” from the extension of tax policy and the payroll tax holiday will translate into growth or an increase in the savings rate. My thought is any boost will be negated by rising energy prices. Yes Virginia, oil is going over $100 again. Eventually investors will demand some closure on government debt and the consequences of same.

Lastly, if interest rates continue to rise into the second half of the year then all bets are off. So we’ll position for the second half like we did in 2010, which means the portfolio will definitely be defensive. Dividends and dividend growth will be key in 2011, as will knowing when to call it a day on our big gainers.

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