Twitter Sentiment
We were very reluctant to "get on Twitter" a few years back, but have found it to be a great source of anecdotal information allowing us to monitor investor sentiment. Since the October 9 intraday low in stocks, the trend in Twitter-land has been skeptical, rather than bullishly euphoric. If we tweet bullish charts, they are met by crickets. If we tweet something bearish, it immediately gets "favorites" and re-tweeted. Anecdotally, this aligns with "I am underinvested and I hope the market pulls back so I can redeploy my cash", rather than "I invested all my cash weeks ago and I need the market to go up to confirm my analysis". The topic came up on Twitter this morning, and true to form Twitter-land backed the bearish case, which we pointed out below.
When Everyone Is Bullish
Sentiment analysis is based on the theory that when everyone is bullish everyone has already invested their cash. If everyone has invested their cash, then buying demand is just not there and stocks will drop. Therefore, if we were at a euphoric and excessively bullish point in history, we would expect investors to be "all in". Our objective in this article is to address the argument that retail investors are fully invested and thus stocks have lost all sources of buying demand. We are not attempting to address all bearish arguments; many of which are valid.
Mutual Fund Flows Far From Euphoric
If investors were broadly bullish, we would expect to see positive mutual fund flows over the past three years. Mutual fund assets have increased by only 2% so far in 2013, which does not seem like an irrational rush to get in the stock market. In 2011 and 2012, investors pulled money out of stock mutual funds. From CNBC:
According to Lipper, stock mutual funds have seen inflows of $167 billion so far in 2013, after outflows in 2011 and 2012. That's good news, but it is hardly a surge. Although $167 billion seems like a lot of money-and it is-it is only about two percent of the $7.2 trillion in stock mutual funds. That is not a tidal wave.
Trading Volume Far From Euphoric
Wall Street veterans who witnessed the dot-com bubble know what an irrational and euphoric rush into stocks looks like. Between Q1 1997 and Q1 2000, average daily volume on the NASDAQ increased by 186%. Between Q1 1997 and Q1 2000, average daily volume for stocks in the S&P 500 increased by 111%. That is in sharp contrast to what we have seen in the last three years, where average daily volume for S&P 500 stocks has declined by 21% (you read that right, a drop in volume). If retail investor demand was increasing at a euphoric rate, we would expect to see trading volumes surge as they did between 1997 and 2000.
How About ETF Volume?
If you are thinking the numbers above reflect a shift toward ETFs, ETF volumes paint a similar disinterested, rather than euphoric, picture. The S&P 500 ETF (SPY) is the golden child of the ETF industry. SPY's average daily volume in November 2011 was roughly 245M shares. If investors were piling into ETFs in a euphoric or irrational manner, we would expect to see a big surge in SPY volume. That is not the case. In fact, average daily volume in November 2013 is just 116M. Over the past two years, trading volume for SPY has decreased by 53%, which does not align with the "retail investors are all in" case.
Everyone Is Bullish?
If you watched CNBC or read the financial pages between 1997 and 2000, you remember the ridiculously bullish bias in the majority of articles. When we checked the futures the morning of Tuesday, November 12, 2013 these stories appeared under "news you may like" on CNBC.com:
- Three reasons a stock plunge is coming.
- Look out! A 1987-style crash is coming.
- 'Giant reset' looming for markets.
- Is stock market about to get ugly?
- Why technicians see red flags for stocks.
- Three reasons the market is peaking.
- Why this could be an awful week for commodities.
- Bulls, you are 'being fooled' again!
- The risk investors are missing.
- S&P 500 is going nowhere, except down.
The headlines above look nothing like irrational euphoria, and they look nothing like what the financial press was writing about between 1997 and 2000.
Peak? Maybe; Euphoric Peak? Not Even Close
The moral of the story is when you hear talk of bubble behavior and excessive bullishness, remember the evidence does not support that bearish thesis. The numbers say what they say. If anything, we should be concerned about a lack of demand for stocks, rather than euphoric demand. Could the stock market top soon? Sure it could, but it won't be based on "everyone is all in" or "investors have bullish-colored glasses on".
Investment Implications
Twitter, financial TV, and stock market articles are full of predictions and forecasts. Have you ever thought about what a stock prediction involves? If not, this video clip comparing betting on football and forecasting the stock market may shed some light on the odds of your local talking head getting it right. We believe paying attention to the market's pricing mechanism is much more productive than trying to predict what will happen next.
Common sense tells us that a trend that "goes straight up" is not sustainable. That same concept applies to all advances in financial instruments; the steeper the slope, the less likely the trend will continue. As you can see below, the present day slope of the NASDAQ's bullish trend is much more sustainable than it was during the dot-com mania.
The market's pricing mechanism told us to begin redeploying cash on October 10 and is still sending "stay long for now" signals. Therefore, we continue to hold positions in U.S. stocks (SPY), technology (QQQ), financials (XLF), energy (XLE), foreign stocks (EFA), and emerging markets (EEM). Since flexibility is a core tenet of investing success, we must be willing to reduce our exposure to stocks when the observable evidence changes. Are their reasons to be concerned about the stock market? Yes, but extreme optimism or investors being "all in" are not on the list.
