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On top of the negative sentiment from investment advisory services, the actual behavior of investors has also gone negative with short positions in the S&P500 index (i.e. bets that the market will fall) increasing sharply over the past two months to the highest level in four years. The history of this indicator as a forecaster of stock prices is not really that good since it is relatively short, but the notion that you want to be somewhat contrarian (i.e. not moving with the crowd) would certainly point you in the direction of being more bullish than bearish, since it seems that many large investors have placed themselves in a position to benefit from a market decline.
The stock market forecasting 11 of the past 6 recessions is certainly one of the old adages that investors have used for a long time but so is the phrase that ‘stocks will move in the direction that causes the most pain to the greatest number of investors.’ If our sentiment indicators referred to above are at all accurate, then the direction of most pain for investors would be a rise in prices!
How does the global economy escape a meltdown? When talking to investors and advisors this seems to be the biggest concern. With the problems in Europe, the U.S. debt crisis and even some fears about a slowdown in some emerging market economies, where does the stimulus to grow the economy out of this hole come from? Investors seem to be looking for some ‘magic bullet’, a policy statement or change that will quickly bring these changes about. But with interest rates already at all-time lows and government finances so strained, maybe the authorities are out of ammunition to initiate any stimulus.
Our view continues to be that many investors are ignoring the secular growth story going on in the emerging economies, which now make up a significant 30% of the global economy. They are embracing capitalism and expanding industrial production at the greatest rate we have seen since North America and Europe after the end of the second World War. Governments and consumers in those economies are also net savers, meaning that they have the ability to supply capital to support their continued growth. Also, the US consumer is now in much better shape than they were during the financial crisis. Three years of debt de-levering is starting to work and personal balance sheets are starting to come down to more normal levels. Meanwhile, the business sector is in better financial shape than it has ever been. US companies are sitting on a combined total of over US$2 trillion in net cash that is slowly being deployed back into the most attractive economic opportunities, including expansion, acquisitions, capital spending, stock buybacks, dividend increases and even increasing payrolls. The problems of some financially-impaired European economies on their own will not be enough to bring down the global economy. In over 30 years of meeting companies, I have yet to hear of one saying that any of their growth issues were due to slowdowns in Greece, Italy, Spain or Portugal! We continue to believe that stock investments made today will yield substantial returns over the next few years, particularly compared to the expected returns on bonds or cash over the same period. There are just no guarantees that things don’t get worse in the short-term since it’s hard to quantify levels of panic. One more final old adage is that “no one rings a bell” at market bottoms. But the ringer might be muted and it’s probably vibrating wildly right now!