As the warm summer temperatures fade into the past, the stock market’s rally over the past few months has also run into a bit of a roadblock.  What investors dislike most is uncertainty and they seem to have a lot more of it lately. Between the U.S. Election jitters, lukewarm third quarter earnings reports, continued worries about economic growth in Europe and China and fears about the upcoming ‘Fiscal Cliff’ in the U.S., investors have more than enough uncertainty about the next few months.  This has pushed many investors back onto the sidelines as stock prices drifted lower.  Basic resource and technology stocks have once again suffered the brunt of the damage.  Although the November-January period is typically the strongest seasonal period of the year for stocks, many strategists worry that we may have already seen the highs in stock prices for the year as the disappointing earnings guidance seen in the past two weeks and the other economic risks will keep investors on the sidelines until some of these headline risks diminish.

While we did reduce some equity exposure last month following the strong gains in the July-September period, we are only expecting a short-term, shallow retreat in stock prices and still think we will see the market reach higher levels before the year is out.  Our confidence comes from a variety of sources that we detail below, key of which are the ongoing recovery in the U.S. housing market, the historically low level of stock valuations, the continued support from Central Banks everywhere and a reduction in some of the weaker economic data-points outside of the U.S.

Investor sentiment continues to be bearish.  We also like to monitor the ‘sentiment’ of investors, strategists and writers to see where the current consensus appears to be, hoping always that we can spot tops and bottoms in markets when investors are at their most optimistic or pessimistic, respectively.  Looking at the key headlines from the respected financial journal, Barrons, this past weekend tells us very quickly what the consensus view is.  ‘Preparing for a Stall in Stocks’, ‘Precipice Anyone?’,  ‘A Cliff Too Steep’, Even for DC’, ‘Bye, Bye Bull’ and ‘Dow Falls As Fears Mount.’ 

It’s not just the news writers who are putting out warnings.  A recent study from State Street Global Advisors  warns that a so-called tail-risk event, an external shock that causes a market sell-off and potentially threatens the financial system, will happen in the next year.  State Street indicated that the world’s biggest investors fear a fresh market crisis will erupt in the next 12 months amid worries that troubles in the Euro-zone will hit global growth and cause disruption in the financial system similar to the collapse of Lehman Brothers.  Two thirds of the investors surveyed said the event would be triggered by the global economy falling into recession, another two thirds said it would be caused by the break-up of the euro and a fifth said it would be caused by a bank insolvency.  Others cited a slowing Chinese economy, an oil price shock and monetary stimulus causing new asset bubbles that would create financial turbulence as possible causes of a fresh market crisis.  Only 20 per cent of the respondents were very confident that they were protected against tail-risk events. 

Taking the fear factor one step further, have a look below at the most recent survey from AAII (American Association of Individual Investors).  Bullish sentiment is almost 10 points below the long-term average while bearishness is 13 percentage points higher.

This week’s AAII Sentiment Survey results:
Bullish: 29.2%, up 0.6 points
Neutral: 27.7%, up 0.9 points
Bearish: 43.1%, down 1.5 points

Long-term averages:
Bullish: 39%
Neutral: 31%
Bearish: 30%

If you’re worried then it’s clear that you’re not alone!  But if you like to ‘lean against the wind’ a bit and not go with the consensus, then it would seem like adding to stocks in the current environment would be the logical choice.

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