Time for a Breather Second Quarter Market and Economic Outlook

At the close of the first quarter, the headlines are jubilant.  The stock market had its best first quarter in 14 years.  The Dow was up 8% and the S&P 12%.

What we believe will follow this impressive quarter, is a period of stagnation.  We think it’s time for the market to take a breather and could easily net flat results.  As such, over the last coupled of weeks, we’ve paired equity positions back on in our discretionary portfolios.

Our thinking is shaped in large part by investor sentiment.

Investor sentiment is a term used to describe how investors view the stock market.  We analyze investor sentiment using 26 different factors.  We do this to help us determine when investors have reached a saturation point of bullishness or bearishness.

In October, 2011 virtually all the investor sentiment dimensions we looked at pointed in the same direction.  They were bullish.  We acted accordingly and increased equity positions in our discretionary portfolios.

Now, however, we are seeing nearly the exact opposite phenomenon.  Some of the dimensions are even out of the extreme fringes.

Take, for example, the Rydex Asset Ratio.  This ratio measures assets flowing into bull versus bear funds.  Rydex calculates the bear/bull asset ratio and monitors the relationships between assets in these two types of funds.

At the height of the market in the 2000’s, and at the peak of the technology bubble, the Rydex ratio was at 4.  There were four times more assets in the bull funds as there were in the bears.  Again, in 2007, right before the major market retreat of 2008 and 2009, the Rydex Asset Ratio was again at around 4.

Today, the ratio is over five.  In the history of this data set, it has never been this high.

The Rydex Asset Ratio is just one example, but it is an example in the extreme.  It alone does not portend much.  When considered with other sentiment measures, it paints a picture of extreme bullishness and complacency towards risk.

We’re not bearish for the foreseeable future.  We believe that the market will be taking a breather.

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