When Should I Buy?

Back in April during the week of the stock market highs, I wrote an article titled America Is Back: The Stock Market.  In the article I discussed the importance of tracking investor psychology and sentiment as an investing tool.

I want to discuss that topic again this weekend because I feel we are already at or closing in on another important moment of extreme sentiment.

The fundamentals for stocks, which I discuss on a daily basis, are horrible.  We received data this week showing the 19th consecutive week of investors removing capital from stock market focused mutual funds.  In addition, the month of August showed investors removing money from stock market focused ETF's.

The money is being re-allocated to bond funds.  This is viewed by some market observers as a good thing because it means there is more "cash" on the sidelines ready to invest.  The problem is that investing in bonds is not investing in cash.  Most investors are moving into funds that have an attractive yield (interest rate) which are very risky.

An example from a Bloomberg article this week:

Issuers have sold $4.4 billion of bonds tied to subprime auto loans this year, more than double the amount arranged in 2009. While sales plunged during the housing crisis of 2007 and froze after Lehman suffered the biggest bankruptcy in history, investors are now snapping up similar securities attracted by their yield.

The actual "cash" on the sidelines for mutual fund holdings today is at 3.4%This is the lowest percentage in the 60 years it has been tracked This means funds are 96.6% invested in the market. 

The American Association of Individual Investors (AAII) poll shows that 50.9% of investors are currently bullish on the stock market.  This is above the April high of 48.5% bullish.  The percentage of bears is currently at 24.3%, lower than during October 2007 (the month the market was at the all time record high) when the percentage of bears was at 25.3%.

The daily sentiment index read 83% bullish this week.  This means only 17% of investors polled felt the stock market was going lower.

What justifies this bullish outlook?  One of them is an investing tool called a P/E ratio.  This is the price of a stock divided by the future earnings.  The key word is future because analysts use earnings estimates looking 12 months in advance and their estimates show a full recovery in the economy. 

Look at some other extreme daily sentiment readings for assets this week:

Sugar: 98% bullish
Corn: 96% bullish
Oats: 96% bullish
Yen: 92% bullish
Swiss Franc : 95% bullish
Euro: 85% bullish
Silver: 93% bullish

Some assets on this list I love (silver, agriculture, Swiss franc) and others I do not.  Tracking the sentiment helps me understand when to utilize cash to add to my investment positions.

It is no secret that I love silver, but I do not like to buy it when other investors love it.  The same goes for other investments I love (gold, energy, Aussie dollar, Canadian dollar).  Of those four, energy today is the least favored in the marketplace, and therefore would be the most attractive addition to my portfolio.

As an investor I would recommended learning and studying to build your own conclusion on what the long term outlook for certain asset classes will be based on fundamentals.  THEN you can utilize both technical analysis (stock charts) and sentiment readings to determine when to add to your long term positions.