Contrarian bears often view a high level of optimism as a sign that the market may be hitting a top. The theory is that when everyone is bullish and feeling positive, then they have already acted on those emotions and there isn't much buying power left to send things higher.
It isn't a very precise way to time the market, but it does have a certain logic. Based on the huge rally off of the December 24 low, it would seem reasonable to believe that market players are heavily long and running out of buying power.
According to a survey from Bank of America Merrill Lynch, that is not the case. Bank of America reports that investors holding more than $500 billion in assets have the lowest exposure to equities since September 2016, and those that are long tend to be mostly in defensive stocks.
Many of them have not trusted this huge bounce after the steep losses they suffered in the fourth quarter of 2018. They are lagging their benchmark indices and still harbor doubts that the market has shaken off whatever it was that caused the problems at the end of 2018.
This is a classic illustration of the dynamic known as "climbing the wall of worry." Skeptics are sitting on the sidelines with high levels of cash. As the current rally continues, they grudgingly put small amounts of cash to work so they won't be left behind. That incremental buying pushes the indices higher, causes more anxiety about being left out and triggers more buying. The more that these money managers lag their benchmark indices, the more they worry and the more inclined they are to capitulate and put more cash to work.
The bearish spin on this is that maybe all those money managers have some very valid worries. Perhaps they are holding high levels of cash because they have a clear view of the problems that lie ahead.
Maybe that is the case, but their timing isn't very good. They didn't see the correction coming in the fourth quarter and they didn't anticipate a bounce in the first quarter of this magnitude. Their judgment about the market doesn't seem to be very good.
The important lesson of this information is that trying to time when this market is going to reverse is nearly impossible. The best course of action is to stay with the trend and try to ride the upside as long as it continues.
At some point, the market will reverse, but with all this idle cash on the sidelines it appears it is likely to continue higher than many people think it will.
We have a positive open this morning, as market players remain calm in front of tomorrow's interest rate decision.
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