Quite a while ago, I had an interesting conversation with a smart fundie manager. We had opposing views about many things. In particular, we disagreed upon was the value of (non-price) sentiment indicators.
His argument was that when stocks get cheap enough — as reflected in their Prices, P/Es and cash flow measures — other indicators don’t matter. One can detect extreme sentiment by how under- (or over-) valued stocks are. By definition, value investors are not believers in the Efficient Market Hypothesis. Long time readers know that neither am I.
My sentiment counter arguments: At the time of our discussion in early 2007, the Home Builders and Banks had looked very cheap on P/E basis alone, while Google and Apple looked pricey on the same basis. That was a direct assault on P/E as a valuable indicator, at least as a stand alone metric. (Good thing he didn’t like the banks for other reasons).
But it was the sentiment issue that was the most interesting part of our friendly debate. I was challenged to identify a magazine cover or Page 1 newspaper story that was a contrary indicator in real time. A few weeks after that friendly wager was made, the WSJ had a page one article titled, Why Market Optimists Say This Bull Has Legs.
That was May 23, 2007, exactly one year ago today.
On that very same day, I posted this: Uh-Oh: Front Page WSJ “Why Market Optimists Say This Bull Has Legs”. Specifically, I wrote:
Today’s WSJ has a very bullish, front page article on the current Bull market lasting another decade or so. In the past, that has operated as a bit of a warning sign that an intermediate top was nearing.
That turned out to be a fairly timely warning. At the time of the WSJ article, the major indices stood as follows:
Standard & Poor’s 500-stock index 1524.12
Dow industrials 13539.95
Nasdaq Composite Index 2588.02
Markets sold off a few months later, making a low in August, rallied to new all time highs in october, and have since made new lows in January and March, prior to rallying about 10% off of those lows.
Now, one full year later, we can review each of these indices It turns out they are substantially lower: The Dow at 12625.62 is nearly 1,000 points lower; Nasdaq at 2464.58 is about 125 points lower; the S&P 500 at 1394.35 is ~130 points below.
That’s a 5-10% drop, versus a risk free 4.87% yield on the 10 year. That’s before substantial gains from bonds, which rallied in the face of aggressive Fed cuts.
While this does not conclusively prove the utility of the Cover indicator, I believe it certainly is a bit of weight in is favor.
Why Market Optimists Say This Bull Has Legs
They See Decade of Gain Fed by Global Growth; Skeptics Cite Big Doubts
WSJ, May 23, 2007; Page A1
Since we get existing home sales later today:
James Galbraith, an economics professor at the University of Texas,
talks with Bloomberg’s Matt Miller from Austin, Texas, about the
outlook for the U.S. economy and the challenges facing the next
president, the impact of Federal Reserve monetary policy on inflation,
and the state of the U.S. housing market.
click for video
James Galbraith Says Housing Problem to Last `Long Time’
Bloomberg, May 16 2008