Breaking Down Investor Bullishness


Stocks were up for a second consecutive day -- barely -- with the S&P 500 gaining less than 0.1%, while the narrower, price-weighted Dow Jones Industrial Average fell just over a quarter of a percent. For the S&P 500, this marks another five-year high -- stocks have not closed higher since the end of October 2007.

Even so, the VIX , Wall Street's fear gauge, rose 2.7% to close just below 13. (The VIX is calculated from S&P 500 option prices and reflects investor expectations for stock market volatility over the coming thirty days.)

Measuring sentiment
And speaking of the VIX, it's an indicator I follow closely as a short-term indicator of sentiment; recently, I've been surprised to see it plumb depths not seen since before the nadir of the credit bubble, suggesting a level of investor complacency I find unsettling (low VIX values indicate weak demand for protection against price declines in the S&P 500). Indeed, before this year, you need to go back to June 2007 to find a closing value for the index that is lower than today's. The index is now close to the bottom 10% of its historical range, going back to its inception in January 1990.

Similarly, B of A Merrill Lynch has just developed a Bull & Bear Index to track investor sentiment on a scale of 0 (most bearish) to 10 (most bullish). The index's current value, 9.6, places it in the 99th percentile of its historical range since 2002 -- i.e., investors are now more bullish than they were during 99% of the prior decade.

Still, something about these indicators seems off. Which investors are we talking about? The data on mutual fund flows make it pretty clear there is still a distinct lack of exuberance among individual investors. Even despite the uptick in money flowing into equity funds, individuals continue to favor bonds over equities. Clearly, the bulls pushing stocks higher are of the institutional breed, not retail. Indeed, according to the latest B of A Merrill Lynch Fund Manager Survey, 51% of asset allocators said they were overweight global equities in February, against just 12% in January 2012.

Current (institutional) exuberance leaves risk assets vulnerable to a correction in the event of a policy or economic road map, and these risks are certainly out there. However, it's not inevitable -- as I pointed out this morning, one superinvestor believes the shift of money into risk assets favors stocks. Either way, fundamental investors must accept the possibility of a near-term correction and stay focused on valuations and their goal of harvesting long-term returns.

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Fool contributor Alex Dumortier, CFA, has no position in any stocks mentioned; you can follow him on Twitter, @longrunreturns. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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