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Contrarians Take Note: The Crowd Might Be Right . . . This Time


As regular readers of this blog know, I love Steve Leuthold, the investing veteran and founder of the Minneapolis-based mutual fund company and research house. I love reading the statistic-heavy research publication, Perception for the Professional (a.k.a. the Greenbook, because of color of its color), but I also enjoy Leuthold's own interim report, View from the North Country. (Technically, the publications are put out by Leuthold Weeden Institutional Research; Weeden, based in Greenwich, is a market maker and trading outfit for institutions.)

Disclosure: I am invested in Leuthold's Core fund, LCORX, which is up 2.73 percent YTD (thru 3/21) versus 3.78 percent for the S&P 500. Oh, Steve Leuthold is known as something of a curmudgeonly bear, which is why when he is outright bullish, I pay attention. He called the bottom of the market in 2002 in our own pages. (Well, he adapted it from his own research report for us to publish.)

Anyway, in his research note published today, Steve Leuthold writes:

In March the current bull market celebrated its second birthday, with the S&P 500 up about

100% from the pit of March 2009. Now, after two years of rising prices, investors finally seem to have

become believers in the economy and consequently the market, what Doug Ramsey, in the March

Green Book, labels the “point of recognition.” A recent ISI poll of professionals found that 80% are

now bullish. In addition, individual investors, based on a surge of U.S. focus mutual fund inflows, have

finally become more optimistic (see chart later in this section).

To contrarians, this unanimity of optimism may imply “the end is near” for this bull market.

But maybe not yet. Doug Ramsey notes his study of market history indicates that bull markets underway

for two years have about a 50% chance of carrying at least one more year. But he also observes

that the strongest gains frequently occur during the “disbelief” or “denial” phase. I think this phase

ended in December 2010, as the double dip crowd beat a hasty retreat, and the great majority of strategists

(including me) called for a S&P target of 1400-1450 in 2011 as the recovery of the U.S. economy

continued to surprise.

 Yes, it pays to be contrary, but not all the time. Clearly there are times where the consensus

can be right. I suspect this may now be one of those times.

 My current market opinion? I am sticking to my current projection of

1400-1450, but I do have some concerns… If the Major Trend shifts to

negative - even before this target is achieved - we will look to move our

equity exposure down toward our lowest level of 30%.

 Why do mutual fund investors underperform? We take a look at why I

think it is absurd to think most individuals are capable of directing their

personal retirement funds, a reality many politicians still refuse to recognize.

 Tech is now the biggest overweight in Select Industries. It’s profit margins have never

been higher. Can it get much better? Maybe, but I am having second thoughts…

 Charlie Sheen might have Tiger Blood, but we have our new “Healthy Tigers” Index of

Emerging Asia Health Care companies. I think this is an intriguing investment area, and

it is one I am considering using.

The Crowd Can Be Right For A While

Yes, it pays to be contrary, but not all the time. In my decades of experience, the big pay off for the contrarian comes at valuation and psychological extremes when valuations are in the bottom quartile (like Q1 2009) and investor panic and fear is oh so clear. Or at the other end of the spectrum, when valuations are at upside extremes (top 5%), or most of the crowd has come to believe it really is a new era, and overloaded in the latest fad (1999-2000). But, nevertheless, clearly there are times where the consensus can be right. I suspect this may now be one of those times.

 Based On History, The Market Has Not Gone Too Far, Too Fast

This bull market began in the low quartile of our historical PE valuation studies. Seven of the seventeen

past bull markets (1926 to date) had emerged from this bottom quartile and posted a median 158% gain

over the following 2.7 years.

 Current Market PE Still Below Historical Extremes

Per our PE valuation history, the S&P 500 is in the 70th percentile of 1957 to date distribution (mildly

overvalued) with S&P 500 at 1450 it would rank in the 82nd percentile. Currently the 90th percentile

would equate to the all time S&P 500 high (1585).

 Most Institutional Portfolios Still Below Typical Equity Exposure?

Since the start of the December 2010 institutional “point of recognition,” there has been an underlying bid

that has kept market declines in check, as institutions expand equity exposure. This probably still prevails

today and may very well explain the minimal corrections since December 2010.

 U.S. Economic Strength Continues To Surprise

In February and in early March the economic news continues to impress. For example, retail sales, declining

unemployment, vehicle sales and production estimates, and confidence measures (corporate and individual).

Most investors now closely associate this obvious economic improvement and a continued strong

stock market, although this will not always be the case.

 Stock Market Internals Remain Positive And Some Are Improving

Our Major Trend Index remains positive with a ratio of positives to negatives of 1.12, but this is still close

to the “neutral” zone of 0.95 to 1.05. Surprisingly, the Momentum/Breadth/Divergence category of indicators

is now improving. Market Breadth work (Advance/Decline data) is now stronger than the market

averages. Some of the overbought measures have also worked off their excesses in recent weeks. The bad

news, be it higher oil prices, Middle East conflict, or surging commodities, is being shrugged off by the

market with minor temporary corrections. As mentioned above, declines are being kept in check.

The Leuthold Group—March 2011; View From The North Country

Published By The Leuthold Group, LLC March 2011

Vol. 4 No. 2

Distributed By Weeden & Co., L.P.


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