Stock Market Reaches For New Highs Even As Risks Rise

September 13, 2013

The stock market took advantage of the lack of economic reports this week to rally back toward its bull market highs. The previous week’s economic reports, particularly the dismal employment report last Friday, were forgotten as the threat of a military strike against Syria faded.

Concerns about the Fed dialing back its QE stimulus remained in the air. But that worry retreated also. The consensus opinion is that the weak employment report will force the Fed to do very little if anything except emphasize its intentions to do no harm by taking it slow and easy with any taper.

Meanwhile, ignored by the market, the economic risks worsened.

Even though there were very few economic reports this week, what there were did not paint an encouraging picture.

It was reported Friday that Retail Sales were positive by only 0.2% in August, the smallest increase since April, and less than half the consensus forecast for a 0.5% improvement. The University of Michigan/Thomson Reuters Consumer Sentiment Index plunged from 82.1 in August to 76.8 in September, a five-month low. The Producer Price Index was up an unexpected 0.3% in August on the back of higher food and energy costs. And the Mortgage Bankers Association reported that mortgage applications fell by 13.5% last week.

Against that backdrop, next week returns to a normal schedule of important economic reports, including the first look at the housing industry in a while, with the Housing Market Index, New Housing Starts, permits for future starts, and Existing Home Sales.

And the Fed’s highly anticipated ‘will it or won’t it’ September FOMC meeting will begin on Tuesday, with its QE taper decision being announced on Wednesday, and Chairman Bernanke’s often provocative press conference following after the announcement.

Can Chairman Bernanke pull off the potentially confusing balancing act of lowering the Fed’s economic growth estimates again, as it’s expected the recent economic reports will force it to do, while at the same time convincing markets that the QE stimulus, which has been the main support for the economy for five years, can now be safely dialed back?

Meanwhile, on the market’s continuing rally, Goldman Sachs reported that the market’s gains this year have been driven much more by the expansion of Price/Earnings multiples than earnings themselves. That is, the willingness of investors to pay higher prices for stocks regardless of slowing earnings growth. The report notes that of the S&P 500’s 18% gain this year, only 5% is related to earnings, and 13% due to an increase in the Price/Earnings multiple investors are willing to pay.

Will so-called smart money continue to be wrong with their concerns over such situations, while public investors have been so right in pouring money into mutual funds and ETF’s at a near record pace this year?

That divergence in expectations apparently continues.

The Consensus Inc. Bullish Sentiment Index of professional investors reached a high 78% in March and has plummeted to 50% since. Meanwhile the poll of its members by the American Association of Individual Investors (AAII) has moved in the opposite direction. It jumped to 45.5% bullish this week from 35.5% last week, and from only 28.9% bullish in August. (Not that it necessarily means anything, but it was at 45.1% bullish the week of July 25, the week before the ugly August market correction began).

And while bullish investors are making profits with their renewed confidence this year, hedge funds have had too many bearish positions and are having one of their worst years ever.

Even Stanley Druckenmiller, founder of Duquesne Capital, and former portfolio manager for George Soros’ Quantum Fund, with one of the hedge-fund industry’s best long-term track records, said this week that he is “lost” regarding this market. In a rare appearance on Bloomberg TV he said, “My guess is I believe the market is topping . . . But right now I’m lost. I don’t play when I’m lost, because I know in the future I won’t be lost.”

Investors and the media may not believe that hedge funds won’t continue to be lost. As always, investor sentiment turns quickly, and in spite of their long-term records, hedge funds are being written off as no longer being ‘smart money’, as evidenced by articles like that in Bloomberg BusinessWeek in July titled ‘Hedge Funds Are For Suckers’.

There is no question, as this week showed, that smart money continues to be wrong with its nervousness, and non-professional investors continue to be right with their enthusiasm and confidence.

How much would I bet it will continue indefinitely? Not much.

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Sy is president of StreetSmartReport.com and editor of the free market blog Street Smart Post. Follow him on twitter @streetsmartpost. He was the Timer Digest #1 Gold Timer for 2012 (Gold Timer of the Year), as well as the #2 Long-Term Stock Market Timer.

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