Bullish Sentiment Rises to Extreme Despite Poor Long-term Outlook

| December 22, 2010

Market sentiment has moved to an extreme level with more than 57% of newsletter writers expressing a bullish bias and only 20% indicating a bearish one at the end of last week. This type of sentiment extreme is typical given the type of overextended rally that has occurred in stocks since the beginning of September.

Additionally, the volatile sentiment swings that we continue to experience are common during this stage of a secular bear market. In early September, only three months ago, bearish sentiment was at 37% and bullish sentiment was only 30%, even as short-term cycle analysis was signaling that a meaningful bottom was in place.

From a purely contrarian standpoint, the current sentiment readings suggest that the rally is vulnerable to an abrupt and potentially violent correction, but there is also very little fundamental support for such a bullish view from a long-term investment perspective. As we note on a fairly regular basis, forecasting models based upon current earnings and dividends produce highly reliable outlooks for stock market returns over the long-term, and those models currently paint a bleak picture for the next decade. The folks at Hussman Funds track a number of different models, and their projection composite currently predicts that the S&P 500 index will produce an annual total return of only 3.6% during the next ten years.

Notice how closely the red line (actual 10-year returns) tracks the blue line (projected 10-year returns). There have been some deviations, of course, as stocks performed worse than expected in the 1970s and better than expected in the 1990s, but overall these models have produced highly reliable forecasts during the past 70 years. Right now, they are indicating that the investment outlook is poor for the next decade, which is precisely what we would expect at this stage of the current secular bear market. There will certainly continue to be trading opportunities, but any so-called experts who insist that now is the right time to buy stocks for the long run are either missing or ignoring the big picture.

Category: Commentary, Market Update

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