INVESTORS ARE GETTING MORE OPTIMISTIC AND THAT’S A BAD THING

Psychology moves markets.  Regular readers know that I don’t like to be in a crowded room with a bunch of people who are thinking the same thing.  As General Patton said, “if everyone is thinking the same, then someone isn’t thinking.”   Investors and fund managers appear to be getting more and more confident about a second half recovery.  The latest AAII report showed a 10% surge in bullish individual investors to 38%.

This reading is once again nearing levels that have been good contrarian levels in terms of future stock returns.

As we noted last week, fund managers are growing increasingly optimistic:

NEW YORK and LONDON, June 17 /PRNewswire/ — The upturn in global investor sentiment has withstood the recent large sell-off in bonds, according to the Merrill Lynch Survey of Fund Managers for June. Investors have expressed confidence in global economic recovery and, broadly, in the equity markets, in spite of their fears the sell-off would damage sentiment. The yield on 10-year U.S. Treasuries rose to 3.85 percent from 3.09 percent between the May and June surveys.

A net 62 percent of respondents believe that the world economy will improve in the next 12 months, an increase of 5 percentage points since May. For the first time since December 2007 the majority of asset allocators responding to the survey are overweight equities – a net 9 percent are overweight the asset class. Just 7 percent of the panel believes that the world will go through recession in the coming year, down sharply from 38 percent in May and 70 percent in April.

“Investors are currently ruling out the prospect of the much-feared double-dip recession, and have shrugged off the weakness in bonds,” said Michael Hartnett, Banc of America Securities-Merrill Lynch chief global equity strategist.

“While investors are finally overweight equities, risk appetite remains relatively constrained. Investors seem happy to underweight defensives at this point, but overweight conviction is tightly concentrated on just two sectors; energy and technology,” said Gary Baker, Banc of America Securities-Merrill Lynch head of European equity strategy.

A recent Reuters poll notes that U.S. fund managers now have their highest equity allocation since before Bear Stearns collapsed:

NEW YORK — U.S. fund managers’ exposure to stocks rose to the highest level this year in June, encouraged by growing evidence the economy is coming out of its worst recession in decades, a Reuters poll showed on Tuesday.

Based on 12 U.S.-based fund management firms interviewed between June 16 and 29, firms held an average of 62.5 percent of their assets in equities, up from 61.6 percent a month earlier and 60.6 at the start of the year.

It was the third consecutive increase.

“We do believe the U.S. economy is close to beginning a recovery,” said David Joy, who helps oversee about $160 billion as chief market strategist at RiverSource Investments in Minneapolis and is now modestly overweight in stocks.

As Warren Buffett famously said, “be greedy when others are fearful and fearful when others are greedy”.  It doesn’t appear to me at this time, that there is a whole lot of fear in this market and that might just be a recipe for lower stock prices in the weeks and months ahead.

*For more on the psychology of trading see here.