Could changing sentiment see a market surge?

16th February 2012

Almost every indicator suggested that fund managers were now willing to take risk again. Cash balances were at their lowest level for six months, the appetite for investing into emerging markets, such as India and China had re-emerged, and the proportion of investors taking lower than normal levels of risk has dropped from a net 42 per cent in December to a net 33 per cent in January.

The article quotes Michael Hartnett, chief Global Equity strategist at BofA Merrill Lynch Global Research: "Investors are tip-toeing rather than hurtling toward higher risk exposure; the U.S. market and high quality cyclical sectors, such as energy and tech, have been the main beneficiaries of lower cash holdings." Although expectations on corporate profits growth have improved, investors are still fearful on Europe.

In many ways, the asset management survey simply reflects what has been going on in markets since the start of the year. There are a number of bloggers saying that they saw it coming: Josh Brown of The Reformed Broker suggests that there are strong technical reasons behind the new-found optimism: "You should know that even if the secular bear market isn't quite through with us, we may have seen the worst of his claws and teeth.  You should study the other secular bear markets and then you'd learn something about "wine glass bottoms".  You'd know that in the 1966 to 1982 secular bear market (and all the others before it), the very bottom for stocks occurred NOT in a crescendo at the end – but rather somewhere toward the middle.  Think of 2009 as the middle and most severe point of this secular bear, picture that Dow 6500 print as the stem of the wine glass.  It doesn't mean we're out the woods, but it does mean that the follow-on sell-offs may not be quite as painful and should subside faster"

Others believe that it's the valuations, stupid. It simply got to a point where stocks were trading too low. As this piece shows, earnings growth expectations have come down sharply, as much as 8% from September of last year, but valuations have come down even further: "There is, however, one explanation for this bizarre disconnect between stocks and earnings expectations: valuation. Indeed, low valuations was one of the key reasons why BlackRock's Larry Fink recommended being 100 percent invested in stocks. Soaring stock prices (numerator) amid falling earnings growth expectations (denominator) is a very quick way for valuations to rise back to historical norms."

There can be no doubt, certainly within Europe, that a diminution – if not quite an elimination – of the risk of a significant problem in one of the Eurozone banks has contributed to a general increase in risk appetite. Jack Barnes writes on the Market Oracle: "It's my expectation Europe is preparing to recapitalize its banks via LTRO to help them weather the coming storm when Greece officially leaves the EU and the focus turns to other weak member states. Remember, whatever deal Greece cuts now, Portugal and Ireland will want to renegotiate their deal. The Greek drama is only the first act. There is going to real market impact when the second refinancing operation (LTRO) is finalized.

What happens after that will be very noteworthy…Soon, thanks to the LTRO, European blue chip stocks could be an interesting place to put speculative funds to work again."

pinetrale on The Huffington Post community boards points out that it didn't take a huge shift in sentiment to see markets rise: "(The market) is climbing the classic wall of worry, just like it always does in a bull market. Big investors sold out of many of their positions last year and now a huge amount of money sits on the sidelines, trillions. To make money again they have to buy. Short of a war with Iran or a comet there really is not good reason not to buy stocks and corporate bonds when money markets pay effectivel­y near 0 percent and treasuries barely a few percent." 

In reality, fund managers' new optimism could be based on any of the above reasons – valuations, the LTRO or technical indicators. It is the fact that they have a range of reasons to be cheerful that should give investors some cause for confidence.


More from Mindful Money:

Some reasons for optimism – but beware the angel of death

Is the 'risk on, risk off' investment style on or off?

Psychological barriers to investment – and why they are ignored

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