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[Given the] big swings in enthusiasm for owning common stocks [we thought it
timely to present] our opinion on the current temperature of the U.S. stock markets as to what’s hot and what’s not and the reasons why that is the case.
The above are edited excerpts by Smead Capital Management (smeadcap.com) from their original article* entitled The Thermometer of the Stock Market.
[The following article is presented by Lorimer Wilson, editor of the FREE Market Intelligence Report newsletter (sample here) and may have been edited ([ ]), abridged (…) and/or reformatted (some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. This paragraph must be included in any article re-posting to avoid copyright infringement.]
The article goes on to say in further edited excerpts:
To take the temperature of the market we need to examine the thermometer readings, namely:
1. Initial public offerings (IPOs) of common stock and trading…
…When the temperature of the stock market is low and people are fearful, there tends to be great hesitancy to buy young, untested companies. The future doesn’t seem to matter when investors are fearful and investor time horizons are squeezed down from years to weeks.
When the temperature of the stock market is high, investors seem to be rabid to buy the next great business concept and willing to stretch the time horizon to decades. We see numerous exciting companies getting funded in the public market and the supply of shares in the growth category is expanding dramatically.
Today, the temperature of the stock market, based on trading in stocks like Facebook (FB), Netflix (NFLX) and Amazon (AMZN), along with the interest in the IPO of Twitter, looks high.
2. Sentiment polls and insider buying
…In the latest week (October 21-25), individual investors, as measured by the American Association of Individual Investors (AAII), and investment newsletter writers, as measured by Investor’s Intelligence, were bullish by nearly a 3-1 ratio to bearish. There have been very few insider buys among the companies which fit our eight criteria. Insider selling has been large and consistent recently, especially among the kinds of titillating companies which the stock market participants clamor for.
Currently, the short-term temperature based on sentiment looks high.
3. The price-to-earnings (P/E) ratio
…Large companies as represented by the S&P 500 Index trade for 15 times the 2014 First-Call consensus earnings estimate. From a historical standpoint, this is a fairly normal P/E ratio and poses little threat to the long-duration common stock investor, in our opinion. This is especially true in lieu of low inflation and interest rates.
The Russell 2000 Index is trading at a P/E of 21 times the First-Call estimate. The courage invested in these more expensive and seemingly risky shares, demonstrates to us that the temperature of …the [small cap] US stock market is high.
4. Institutional and individual ownership
a) Large-cap: Based on the NACUBO study of endowments and Lipper data on mutual fund and ETF money flows, we believe we are very early in the process of reaching more normalized ownership of US large cap equities by the largest pools of money in the U.S.. The temperature reading for large-cap US stocks is still pretty low. The reading on the thermometer won’t get high until we have an economy strong enough to cause the Federal Reserve board to tighten credit in the U.S…. to slow huge momentum in the economy to avoid inflation. This appears nowhere in sight and marks little heat on the thermometer.
On the other hand,…the number of small-cap equity manager requests for proposal (RFPs) have dwarfed large-cap requests over the last four years and has not changed recently. It is no coincidence that small-cap indexes have soundly outperformed large-cap indexes over the last 14 years…[and] Eugene Fama’s…[winning of] the Nobel Prize in Economics (his academic work on efficient markets and long-term positive factors affecting equity performance are the academic work behind the success of many passive equity approaches)…combined with the popularity of the “globally-synchronized trade” and small-caps, leads us to believe the temperature is high for over-weighting the same factors for the future of small-caps that were successfully emphasized in the past…
5. The last point on the thermometer is anecdotal.
The courage shown by investors during the government shutdown and their willingness to stick with more risky and volatile common stocks sends the mercury rising. We sense that folks we interact with who were once fearful of each dip have increased confidence now. In our view, most of the guests on CNBC and Bloomberg are bullish. On top of their bullishness comes their consistent support of cyclical stocks and international and emerging stock market participation. We would include Wall Street strategists on this list of those supporting what worked in late 1999 and looks over-cooked to us.
In addition:
- there appears to be a fever in high-flying momentum stocks
- the temperature is still very high among decelerating cyclical businesses like oil/commodities, heavy industrials and those companies with heavy exposure to the “globally synchronized trade”
- the temperature continues to look very favorable on domestically-oriented US large cap equities which would benefit from the comeback over the next five years in the US economy and are under-owned by institutional and high-net worth investors.
[Editor’s Note: The author’s views and conclusions in the above article are unaltered and no personal comments have been included to maintain the integrity of the original post. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.]
* http://smeadcap.com/smead-strategies/smead-blog/entries/2013/10/29/the-thermometer-of-the-stock-market/ (© Copyright 2012. Smead Capital Management. All rights reserved.)
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