Challenging a Wall Street Myth

 | Jan 09, 2012 | 2:30 PM EST  | Comments
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This commentary originally appeared Jan. 9 on Real Money Pro – Click here to learn about this dynamic market information service for active traders.

After an exciting weekend of football and catching up on my reading, I am convinced of two things: that the Green Bay Packers are the team to beat in the NFL, and that mythology still exists on Wall Street.

Over the past several weeks I have labored to illustrate that the euro-U.S. dollar exchange rate has been reasonably stable over the past several quarters, notwithstanding what you read almost daily in the financial press. Today, I will tackle the myth of the super-contrarian wager that stocks will rise in 2012.

In recent days The Wall Street Journal, The Financial Times, Barron's, and many popular financial websites have been inundated with equity market forecasts for the coming year. And nearly every day, each has a story that strategically combines the notion of rising stock prices with a contrarian bent, explicitly claiming that somehow such an outcome is not popular opinion. Well I have news for the journalists: Most traders and investors not only expect higher prices in coming quarters and the full year, but they are well positioned for it.

The real debate centers on the evolution of this year's trade. Specifically, a small-but-vocal camp expects global equity markets to bottom out sometime in the first half of the year and then launch into the final leg of a bull market that began in 2009. This group also expects significantly weaker prices in the first half, with risk in the S&P 500 down to 1040 or even lower. Regular readers are aware that my own position aligns with this view. What is important to note is that this camp envisions higher prices ultimately.

Another camp, which perhaps holds the majority view, sees a year in which stocks will muddle through and chop irregularly higher as the U.S. economy continues its uneven recovery, corporate profits remain reasonably strong, and the European crisis fails to contaminate the global banking system. They continue to embrace a U.S.-centric world and equity portfolio and have concentrated their books in large-cap, global-growth stocks with relatively healthy dividend yields. They see the markets ending the year on a high note, too, perhaps exceeding 1400 by next year.

What I fail to see and read is a forecast that calls for stocks to plummet and remain down, with both U.S. and European Central Bank policy failures exacerbating problems emanating from a dysfunctional and collapsing banking system. This, my friends, is one contrarian call. Although analysts such as Marc Faber and myself see this as a possible outcome, we also see it as part of a multi-act play and believe that the ensuing monetary and fiscal policy responses will still lift asset values and save the day again. This policy response will be long-term fallacious and damaging but short-term palliative to a lurching financial system.

For bulls, the true contrarian bet is that the market will run higher from gate to wire, much like it did in 1995. Again, my view is predicated solely on anecdotal evidence, but can anyone honestly claim to have seen such a forecast? Since it is the beginning of the year and we can still dream, enjoy reliving 1995 through the chart below.

Source: Bloomberg

A quick review of market positioning today indicates that bullish sentiment is relatively high, even if positioning by  institutional investors is mixed and hedge fund managers low, at least on a net and gross basis.

It is well known that sentiment surveys are running hot, with an American Association of Individual Investors survey indicating the expectation for higher prices six months from now at a ratio of nearly 3-to-1.

Source: Bloomberg

We are seeing the same elevated bullish responses in the other major surveys as well, so clearly the long side, not the contrarian side, is preferred today.

In the futures pits, positioning in S&P 500 contracts remains mixed, with both commercial and non-commercial positions well off levels seen near the market peak in 2007. Speculative net positioning, however, remains near multi-year lows, which generally indicates that the path of least resistance is higher as long positions are added.

Source: Bloomberg

The same study run for the Nasdaq-100 shows a much different picture, however, with net long positions at a much higher level than in the past.

Source: Bloomberg

So beware of Wall Street mythology. The true contrarian bet is to be long European financial stocks, denominated in euro currency. It is not to be long the U.S. market, which appears to be a slightly crowded trade in the shorter term, especially in technology issues.

My expectations for a close above 1280 in the cash S&P 500 have been fulfilled, and the market is fast approaching the mid-month timing target I have been using for the annual portfolio-positioning charade to end. It's time to hedge up and look more aggressively for shorting opportunities -- a better buying opportunity for equities lies ahead.

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