No Matter What The Fed Does, The Lack Of Bears Is Worrisome

The current investor fixation on when the Federal Reserve will drop interest rates and by how much overlooks an important fact – almost everyone is already bullish. So, even if they do drop rates who’s left to buy to drive prices higher?

I believe it was Nathan Rothschild who pointed out this contradiction about investing. He said, “I do what people want. I sell to people when they all want to buy and buy from them when they all want to sell.” What he’s saying is that, to be successful, you must go against the crowd once the crowd gets too big.

Because of this it’s important to have indicators that measure when there are “too many” bulls or bears. We’re going to show you two classic ways to measure it in this article. We covered them in earlier articles.

Low Short Position of Money Managers in S&P 500 Futures

We wrote about this indicator in a November 16th, 2022, article when the investor “shoe” was on the other foot. At that time money managers were heavily short the market. We stated that the high short position of money managers pointed to the end of the bear market. There were just “too many” bears; the market had to go up. It did.

Now we have the opposite condition. You can see that in the chart below.

The graph plots the percent that money managers are short the S&P futures. The data is reported weekly; we average it over 3 weeks to smooth out fluctuations. It’s easy to see the correlation with market highs and lows.

History shows money managers are usually heavily short the market at the bottom and have low short positions at the top; just the opposite of what one would want. In mid 2022 the ratio went to 45% short, which is historically high.

Records also show that any time the ratio gets under 25% it represents a lack of bears and “too many” bulls. We’ve indicated these past moments with black arrows. Each occurred close to the top of a well defined bull market. None occurred prior to, or in the middle of, a bull market. The current ratio is 16.6%, which is the lowest percent since 2008.

We believe this is a very significant fact and suggests that investors should be cautious about this market. Our experience with contrary opinion and markets tells us stock prices will probably be lower a year from now, even if the Fed does lower rates.

The Granddaddy Of Investment Surveys Is Overwhelmingly Bullish, Which is Bad

The oldest investment survey – the Investor Intelligence survey – is the second indicator. It has a storied history that goes back to 1964. Over the years numerous investors and financial writers have referenced it, including the great editor of Barrons magazine, Alan Abelson. Investors Intelligence monitors how many newsletter writers are bullish, bearish or expecting a correction.

The indicator we use is the ratio of the number of bearish writers to bullish writers and the chart below shows this ratio plotted against the Dow Jones Industrials back to 1980.

The black line shows a one for one ratio. There are always more bulls than bears, so we look at relative numbers, not the absolute number. The current ratio of .27 means there’s about four bullish writer for one bear.

As you can see this ratio is historically very low. This ratio easily falls into the category of “too few” or “too many” bulls. Again, with so many investors already bullish, who’s left to buy to drive prices higher?

In fact, with so many people bullish and already invested, it’s easy to get the opposite effect. Any unexpected event could trigger a lot of those already invested to begin to sell. This is the strange world of how contrary opinion works and shows why, at times, investing can be so contradictory.

This Is The Theory Of Contrary Opinion In Action

These two major indicators confirm one another. They both suggest that historically there are just “too many” bulls. They both show this occurs near the end of a bull market, not at the beginning or even the middle.

We believe it’s time for investors to become cautious for the long term. Which brings us up to an important point.

On September 12^th, 2022, near the very bottom of the bear market, we wrote the following:

We are at a unique moment in time to test an important concept.

What’s more important when determining market direction – the negative economic factors everyone thinks will drive prices lower, or the statistical fact that so many people believe prices are headed lower? After 50 years of market study, I say it’s the latter. In any event we will all learn something important very soon.

With the subsequent bull market, hopefully many did learn something important. We think we are at one of those unique moments again, so I’m going to rephrase this question for today’s market.

What’s more important when determining market direction – the positive economic factors everyone thinks will drive prices higher, or the statistical fact that “so many” people believe prices are headed higher? After 50 years of market study, I say it’s the latter. In any event I believe we will again learn something important very soon.

Market Tops Are Different Than Bottoms

Bull and bear market tops and bottoms are different. Bear markets usually end suddenly with different sectors bottoming around the same time.

Bull market tops are spread out over time, with various sectors peaking at different times, forming a fan formation. Locating the top of a bull market is difficult because, while an index might peak, there are often really two or three tops. This topping process can last up to a year.

You can demonstrate this difference by flipping a chart upside down and taking away the price scale. An experienced trader can easily tell the chart is upside down by the reversed pattern structure. Because of this difference you’ll often find bullish sentiment going to extremes two or three times during a bull market top as different sectors peak at different times.

What does all this mean?

The extreme levels of bearish sentiment a year and a half ago made forecasting the bull market rather easy. That, plus the sudden nature of bear lows mentioned in the last section.

But with bull markets it’s different as we said. We have the extreme bullish sentiment that normally occurs near the end of a bull market but that doesn’t mean it’s ready to decline. It does mean, however, that the market won’t advance much from here, no matter what the Fed does.

It also means the S&P 500 will probably be lower than current levels in about a year. What price it will reach before it dives lower is hard to say. We think it could move about 5% higher.

So we are still forecasting $550 in the SPY by late August, which we detailed in this January 22nd article. That target was 15% away when we wrote the article, now it’s only 5% from here.

If it finally reaches that target, we believe the bull market will be spent, leading to an eventual decline below current levels by this time next year. That scenario aligns with the extreme bullish sentiment these two indicators are currently showing, and the way we believe markets work.