The Markets
Contrarians probably are waiting for the other shoe –
or, in this case, U.S. stock markets – to drop.
If you’re not familiar with contrarian investing, the
theory goes something like this: Consensus opinion is often wrong. When the
majority of investors have a bullish outlook and believe stocks are going to move
higher, the chances are stock values will drop. Likewise, when the majority has
a bearish outlook and believes stocks are going to move lower, the chances are
stock values will rise.
Why would Contrarians expect markets to head south? One
reason is bullish sentiment is high. On October 23, the American Association of
Individual Investors’ Investor Sentiment Survey, which measures the percentage
of individual investors who are bullish, bearish, and neutral on the stock
market for the next six months, shows 49.2 percent are bullish and just 17.6
percent are bearish (the rest are neutral). The long-term averages for bullish
and bearish sentiment are 39 percent and 30.5 percent, respectively.
Contrarians also are eyeballing the fact that stock
markets in the United States have run up for 519 sessions without as much as a
10 percent correction, according to Barron’s. That means markets have weathered
bombs at the Boston marathon, chemical weapons in Syria, monetary policy
uncertainty, U.S. government shutdown, and Miley Cyrus’ VMA performance. Of
course, 519 sessions is not the longest winning streak ever, not even close. In
fact, if we assume about 250 trading sessions in a year, then the current rally
would have to last until about 2018 to match the record (1,767 sessions) set between
October 1990 and October 1997.
Investors aren’t the only bullish faction. Money
managers who participated in Barron’s latest big money poll also seem to have
adopted Alfred E. Neuman’s motto: What, me worry? Their outlook seems to focus
on the Fed’s loose monetary policy. According to Barron’s, “Four of five money
managers in our big-money poll expect stocks to be the best-performing asset
over the next year, even as 71 percent see U.S. shares as already fairly
valued. Thanks to unending central bank support, we all expect above-par stock
returns from sub-par economic growth.”
So, what’s going to happen? Only time will tell.
where are interest rates headed? According to the
Federal Reserve, economists assume interest rates will move toward equilibrium or
a ‘natural’ real rate of interest that takes into account inflation over the
long term.
The
idea of a natural rate of interest was first introduced by Swedish economist
Knut Wicksell. Recognized as an
economist’s economist in the late 1800s and early 1900s, Wicksell is known for
his macroeconomic text Interest and
Prices which noted the difference between the real rate of return on
capital (aka: the natural rate of interest) and the market rate of interest
(aka: the rate borrowers pay). According to The
Economist:
“If
the financial rate is below the natural rate, businesses can reap unlimited
profits by borrowing as much as they can and plowing it into high-returning
projects. Eventually, though, all that additional spending pushes up prices,
money and credit, and, eventually, financial interest rates.
Wicksell
saw financial rates as those set by banks competing to make loans. That job is
now performed by central banks. They still think in Wicksellian terms: the
natural rate prevails when the economy is at full employment. Set the policy
rate above the natural rate and the economy tips into depression. Set it below,
and inflation results – or, some worry, speculative credit booms.”
So,
where are interest rates headed? Apparently, they’re going to move higher. According
to the Federal Reserve’s September 2013 economic projections, the federal funds
rate (the rate at which banks lend to each other overnight) is expected to reach
2 percent by the end of 2016. Currently, it is at 0.25 percent. (The Fed also
expects the United States will be close to full employment at that time with
the unemployment rate nearing its long-term average of 5.2 to 5.8 percent.)
Weekly Focus – Think About It
“It
has always seemed strange to me... the things we admire in men, kindness and
generosity, openness, honesty, understanding and feeling, are the concomitants
of failure in our system. And those traits we detest, sharpness, greed,
acquisitiveness, meanness, egotism and self-interest, are the traits of
success. And, while men admire the quality of the first, they love the produce
of the second.”
--John Steinbeck, Pulitzer and Nobel Prize-winning American author
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