When I first became a director of the National Association of Active Investment Managers (NAAIM) back in 2005, one of my projects was to devise a new financial indicator called the NAAIM Survey of Manger Sentiment. I'm pleased to say it is becoming widely followed in the industry with many newsletter writers and websites re-publishing our data (editor's note: SotM publishes the NAAIM Sentiment number every week - here's a link to this week's report) to many thousands of investors and money managers, including write-ups just yesterday on both Forbes.com and Jim Cramer's TheStreet.com.
NAAIM members collectively manage around $15 billion dollars and have widely varying styles that all share one common feature. We all adapt our client's portfolios to these changing markets. The Survey is a way to measure those changes.
Each week the Survey generates a single "NAAIM Number" which represents the average exposure to the stock market across our entire membership. This gives the world a peek at what professional money managers are thinking and doing.
Two weeks ago the NAAIM Number reached a record low of minus 4.18% meaning the NAAIM member managers were mostly out and a little "net short" the stock market, betting that it was going to decline. This is only the third negative reading in the history of the Survey, surpassing the previous record set in October 2008 when the financial crisis was unfolding.
Other "sentiment indicators" covering individual investors, newsletter writers, commercial traders, and more, were also posting very low readings recently, and these became the source of numerous articles all proclaiming that since these readings were so low, the market is about to go up. Another way to say that is that low confidence among participants is a bullish sign.
I frequently say that this is a crazy business, and the backward appearance of these indicators adds to the feeling of craziness. It is not that those surveyed are wrong, but there is more going on than meets the eye, so let me put it in perspective with a review from Econ 101.
The market's price reflects the numbers of buyers and sellers in that market. More sellers make a market go down and more buyers drive it up.
What makes the sentiment indicators look backwards is that if all of those investors are already out of the market, it really means they can no longer be sellers, but can only become buyers. These low readings mean we are in the process of running out of sellers which will stop the market's decline - at some point, anyway.
However, simplistic views rarely reward investors, so I would not jump back into the markets right yet based upon the sentiment indicators.
After the last record low NAAIM Number on October 8, 2008, the market declined for another five months losing an additional 31% of its value. Running low on sellers does not mean there is an excess of buyers, only that at some point it will be easier for buyers to outnumber sellers.
Sentiment Indicators are only one investment tool, and just like mechanics have more than one tool in their bag, so do wise money managers.
Other conflicting (still bearish) sentiment indicators include low mutual fund cash levels at only 3.4% of total mutual fund assets, according to SentimentTrader.com. This means two things. If mutual funds are met with a wave of redemptions they can be forced to sell stocks which in the midst of a decline can drive the market down even further.
Mutual funds also are not in a position to buy much, even if they wanted to. They just don't have the cash, so they are not potential buyers, only potential sellers.
Another negative indicator is the "Smartest Ever" series of books for investors which advocate "A Stress Free Way To Reach Your Financial Goals". Uh-huh.
The series, which encourages investors to buy and hold investments, was launched in 2006, just prior to the beginning of the incredible real estate reversal which was the greatest commodities collapse ever and the greatest stock market decline in generations.
The continuing popularity of this series highlights the remarkable complacency to the downside risk of investing in a buy-and-hope manner. It is one more sign that there is still a large group of potential sellers out there that have just not yet given up on the siren's song of 1990s style easy-money investing.
Yes, there could be a lot more selling since only the quickest to react to the realities of the markets appear to have done so.
I hope that the next wave of selling will be the one that washes out these holdouts and creates a final bottom to the market. That will set up a wonderful opportunity to make money, similar to that which began in 2009, and we will want to be there when that happens.
About the Author: Will Hepburn is President and Chief Investment Officer of Hepburn Capital Management LLC , in Prescott, Arizona. Will specializes in implementing and teaching innovative investment strategies that “Adapt to Changing Markets.” Will is a past President and current board member of the National Association of Active Investment Managers.For more information on Mr. Hepburn, visit HepburnCapital.com
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