The stock market failed to build on the rally from Friday. The S&P 500 fell below support at 1,050 yesterday. Right now, sentiment is just awful across the board. And we’re heading into what’s traditionally the worst two months of the year for stocks: September and October.
Volume in the stock market has been extremely light. This suggests that individual investors are not buying stocks. And we can see that in mutual fund flows. In July, bond funds attracted $25 billion dollars. And investors pulled $12 billion out of U.S. equity funds.
Individual investors seem to be saying that they don’t believe the economic recovery is for real, and they don’t want to be blindsided again by a steep drop in the stock market.
It’s not just individual investors. Analysts currently rate 54% of stocks as “holds.” “Buy” recommendations are at their lowest level since 1997.
Sentiment is as bad as it’s been since March 2009, when the stock market bottomed…
“Contrarian investing” is based on the idea that the masses are usually wrong at the extremes. In other words, when investors are overwhelmingly bearish, it’s time to buy. And when investors think there’s no end to the upside for stock prices, it’s time to look for the exits.
Contrarian investing is not a new, or a radical, concept. Warren Buffett expressed the very essence of contrarian investing when he advised investors “… to be fearful when others are greedy and to be greedy only when others are fearful.”
During the height of the Internet bubble in 1999 and 2000, investors shoveled $497 billion into stock mutual funds. They were just in time for an historic market crash. In the last two years, investors have poured $480 billion into bond funds. While I’m not forecasting an imminent crash for the bond market, the parallels are intriguing.
Of course, no discussion of contrarian investing is complete without mentioning another stock market saw: financial markets can remain irrational longer than you can remain solvent.
There were plenty of investors who saw the insanity of the Internet bubble and started shorting stocks in 1999. I bet shorting Qualcomm (Nasdaq:QCOM) at $450 a share in early December of 1999 looked like a great idea. And I can only imagine what it felt like when the stock crested $700 a share three weeks later.
Are bonds a bubble right now? I don’t know that you can call bonds a bubble. But it’s hard to imagine prices going much higher (and yields much lower).
As we know, bond and stock prices tend to move in opposite directions. With seemingly limited upside for bonds, the contrarian investor should be asking if it’s time to buy stocks.
My answer for both bonds and stocks is the same: trying to pick a top for bonds or a bottom for stocks is risky venture. And while I fully endorse any investor’s desire to be greedy when other are fearful, it’s also important to look for signs that stocks will rally.
Right now, we should be watching the banks and oil prices. Oil is a near-perfect gauge of investor sentiment about economic growth expectations. And financials must lead any market advance.
Financial stocks have certainly led the recent decline. The Financial Spider ETF (NYSE:XLF) peaked on August 2 and has been in a steady downtrend. Bank of America (NYSE:BAC) peaked at $14.50 on August 2 and now trades at $12.30 a share. That’s a 52-week low.
Bank of America (NYSE:BAC) is now trading below tangible book value of $12.40 a share. That means is selling at its “bricks and mortar” price. And the reason is simple: Bank of America (NYSE:BAC) is more leveraged to American households than any other bank. So it should be most vulnerable to the weakening economy.
While we haven’t seen a clear sign that the stock market is set to rally, it’s probably a good time to nibble on stocks with extremely low valuations, like Bank of America (NYSE:BAC).
Economic data released today has been better than expected. The Case-Schiller home price index rose 4.2% when expectations were for a 3.5% gain. Consumer confidence for August jumped to 53.5. That’s much better than the 50.5 economists were expecting.
When consumer confidence rises, it’s assumed to mean that they (we) may spend more. But consumer confidence is also a very volatile indicator. We’ll see if today’s positive reading is the catalyst we’ve been waiting for…
As always, please send me your comments and questions: [email protected].
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Ian Wyatt is an active investor, a well-regarded investment expert and an Internet entrepreneur. He is the Chief Investment Strategist at Wyatt Investment Research, and plays a leading role in each of the company’s investment newsletters and trading services. As a well-regarded market expert, Ian has written for Marketwatch, Zacks Investment Research, Seeking Alpha, Yahoo! Finance and The Burlington Free Press. He has been interviewed or quoted in articles in well-known publications including AOL Finance Blogging Stocks, Kiplinger’s Personal Finance Magazine, Barron Magazine, Barrons.com, Forbes.com, The Dick Davis Digest, The Dick Davis Income Digest, The Wall Street Transcript, TheStockAdvisors.com, Money Show Digest, The New Jersey Star Ledger, The Wisconsin State Journal and The Seattle Times.