The behaviour of bull markets in stocks is often referred to as “climbing a wall of worry.”   The logic of that phrase is that the general skepticism about such an advance prompts most investors to leave more cash out of the market and hesitate to participate in the advance.  As the market continues to rise, investors become more frustrated and worried about being ‘left behind’ and eventually start adding money to the market, which fuels the advance even further.  Eventually enough investors chase the advance and become bullish to the degree that the market becomes ‘overbought’, at which point the bull market tends to end, or at least experience a correction.  This scenario describes quite accurately what has occurred since the market last had a major bottom in March of 2009, as well as in the recent sharp advance that began in August of last year.  In 2009, investor bearishness had reached unprecedented levels with sentiment indicators reaching multi-year lows in terms of bull/bear ratio, insider selling activity and public levels of stock holdings.  Cash as a percentage of investable assets reached a peak of almost 60% of the value of the S&P500 average, almost double the prior high reached at the market lows in 2003! The stock market in Canada has now risen over 80% since that time, dragging more investors in along the way.  Sentiment indicators have improved and cash levels have dropped, but there is still a substantial amount of money that has yet to return to the stock market.  The financial market collapse in 2008 and even the ‘flash crash’ back in May 0f 2010 may have permanently frightened many investors away from stocks, but the continued record-low levels of interest rates is making it much harder for investors to find attractive alternatives to stocks.  A recent report from The American Investor shows that individual’s holdings of stocks as a percentage of their total assets is only at 11.5%, well below the peak of 25% seen in 2007, or even the 22% level seen in 1973, the peak of the last multi-year expansion in stocks.  Investors may be getting their exposure to stocks in other ways such as company pension plans or hedge funds but the point remains that the public, in general, has much less exposure to stocks today than they have typically had in the past.  Two bear markets in ten years will do that to confidence!

So investors are still substantially ‘out’ of the market, which does support a more bullish longer-term case for stocks.  But, in the shorter-term, we have seen a bit of an upward spike in investor sentiment, particularly off the low levels seen as recently as last August.  More active investors such as institutions and hedge funds have been players in the market’s advance over the last two years, and they are showing a bit of short-term buying exhaustion, which could be setting up the market for a correction early in 2011, not unlike the pullback we saw at this time last year. The recent political turmoil in Egypt could be the catalyst for this event, much like the problems in Greece were the catalyst for the correction seen in the spring of 2010 although, in both cases, the events were really more ‘headline shocks’ as opposed to real impediments to economic recovery or corporate profit growth.  However, one indicator that is getting somewhat extended recently is the level of selling by corporate insiders, shown in the chart below.  Corporate insiders, given their familiarity with their own company operations, are generally viewed as more knowledgeable buyers and sellers of their own stocks.  While insiders may sell for a variety of reasons (portfolio diversification, a need for liquidity, divorce settlements, etc), insider buying is generally engaged in for one reason; a belief that the stock price will rise.  So the ratio of insider selling/insider buying has been worth tracking over time.  The ratio is almost always above one (more sellers than buyers) but a very low level of this ratio is usually interpreted as bullish for stocks in general.

As can be seen above, the level of this ratio hit a multi-year low level right at the market bottom in March of 2009, syncing pretty well the stock market low.  Selling increased since then, but then dropped to another low level in August of last year, again coinciding with a market low.  The recent sharp rise in this ratio should not be ignored as it indicates that insiders have become more aggressive in their selling than at any other point in the recent history of this indicator.  While this is not an indicator that should be used on its own to decide on asset allocation levels or stock market timing decisions, it does oblige us to pay attention to other market indicators with more of a negative view.  Once again, we remain quite bullish on the stock market in general and expect that we will go through the old highs either sometime later this year or in 2012, but we are a little more cautious in the short-term given the extended nature of some of these ‘sentiment indicators.’

1 2 3 4