Growing Bullishness: A Sign to Sell or Justified Optimism?

Wall Street loves its superstitions. At this time of year, for example, investors are bombarded with proclamations that the "January effect" should boost stocks during the month despite thin evidence for the belief.

Another supposed truism: Betting against the crowd is always a wise move. That inclination is causing plenty of consternation as swelling investor optimism accompanies a strong rally for stocks to kick off the year.

But investors should avoid this sort of bumper-sticker advice and focus instead on the fundamentals. And when it comes to key factors for stock prices over the intermediate term, like economic growth and valuations, the brightening mood seems well justified.

Reading the Market's Pulse

Also, the impact that swaying sentiment has on stocks may be more complicated than is generally portrayed, according to some of the sharpest investors around.

Barton Biggs, head of juggernaut hedge fund Traxis Partners, had a better sense than most last year of the market's pulse. After a brief bearish spell amid the summer gloom, Traxis quickly turned bullish ahead of the major move upward toward year-end. Biggs recently said the market is overbought in technical regards, and overall sentiment is bullish. But he cautioned that while widespread pessimism can set the stage for rallies, the opposite may not be true.

"We are supposed to be contrarians, so we pay a lot of attention to sentiment and even chart it," Biggs recently said on CNBC. Over the years that Traxis has studied sentiment, "we find it is very valuable when it reaches extremes of bearishness, but not particularly valuable at all when markets get overbought."

A Good Time to Run With the Bulls

Given the steady flow of strong economic reports, growing investor confidence is perfectly understandable. U.S. manufacturing activity accelerated in December to post a 17th consecutive month of gains, according to data released Monday, and construction spending also came in well ahead of analysts' expectations.

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For all the talk of investor euphoria, stocks remain reasonably valued. S&P 500 trades at about 13 times forward earnings estimates. That's a modest multiple by historical standards, particularly since interest rates -- while showing signs of rising amid the current growth prospects -- remain low.

But even as broader market valuations remain grounded, some bulls are pounding the table for big gains ahead.

Larry Robbins of multibillion-dollar hedge fund Glenview predicts the Dow Jones Industrial average will soar to more than 20,000 by the end of 2013, according to some reports. Earnings would grow 5% a year, while earnings multiples would expand 45% in that scenario.

Far-fetched as it seems, that type of bullishness may grow more mainstream if the economy continues to show momentum. And while investors are constantly told to go against the grain, for now, they might find it wiser to go with the flow instead.