The silence of the bears
Market bears outnumber bulls by a wide margin. But stocks continue to climb nonetheless -- and despite evidence that a recovery won't be smooth.
NEW YORK (CNNMoney.com) -- It's hard out there for a bear. The government practically gift-wrapped a perfect scenario for a market bloodbath Friday, but for some reason traders didn't bite.
Unemployment shot up to 10.2% in October -- the first time the jobless rate has been in the double digits since 1983. The number of job losses came in worse than expected as well.
Still, Wall Street shook that off and stocks posted modest gains Friday. Investors instead chose to focus on some of the good news in the job report, such as the fact that job losses for August and September were revised lower.
"It's encouraging that stocks were up even though it was the highest unemployment level in 26 years. The market doesn't want to go down even though people love to hate it," said John Kolovos, co-head of technical analysis research with Concept Capital, an institutional brokerage in New York.
Stocks headed sharply higher Monday as well thanks to some merger chatter. Kraft (KFT, Fortune 500) launched a hostile bid for Cadbury (CBY) while there is talk that GE (GE, Fortune 500) and Comcast (CMCSA, Fortune 500) are getting closer to a deal that would give Comcast a majority stake in GE's struggling NBC Universal media unit.
But here's an interesting tidbit. Even though stocks have, for the most part, rallied sharply in the past few months -- or perhaps because stocks have rallied sharply in the past few months -- more individual investors consider themselves bears than bulls these days. What's more, the margin isn't even close.
According to the American Association of Individual Investors, which conducts a weekly survey of market sentiment, nearly 56% of investors polled last week said they thought the market would be bearish over the next six months. Only 22% of those surveyed were bullish on the near-term prospects for stocks.
To put that in perspective, this is the highest percentage of bearish sentiment found by the AAII since early July and the widest gap between bears and bulls since early March. So what gives? Why are average investors not believing the rally? And are they on to something that the pros are missing?
Well, it goes without saying that the average investor has been wrong for the past few months. The S&P 500 is up more than 60% since the March lows. But can you blame ordinary people for not having faith in stocks right now?
Despite the big gains since March, investors are still nursing wounds from the huge plunge last fall and earlier this year. What's more, the continued bad news in the job market makes it hard for people to truly believe that the economy is in fact getting better.
"Typically after individual investors have been so burned in the market, they are going to shun stocks for a while," said Quincy Krosby, market strategist with Prudential Financial.
Krosby said that retail investors now appear to be betting more on gold and well bond funds because of fears about the economy and the weakening dollar.
However, some think that the sentiment pendulum has swung way too far toward the fear and loathing direction.
Phil Dow, director of equity strategy with RBC Wealth Management in Minneapolis, said he understands why investors may feel that the U.S. economy will never bounce back to where it once was. But he said that the pessimism is overdone.
"Stocks are a dirty word right now," Dow said. "Individual investors are betting that U.S. companies won't participate in an economic recovery."
Dow thinks the global economy is on the mend. And while some Americans are interpreting this as a sign that the U.S. is going to be left behind, Dow said that the U.S. should be a prime beneficiary of growth in China, India and other emerging markets.
"There is a huge global opportunity and it's hard to imagine that the U.S. won't take part in that. But for whatever reason, many investors don't seem to believe that. There is a belief that the U.S. is in this downward spiral and can't compete anymore," Dow said.
So is the U.S. economy as doomed as average investors seem to think? Hopefully not.
After all, investing legend Warren Buffett signaled just last week that he's extremely bullish on the U.S. economy, calling the purchase of railroad Burlington Northern Santa Fe (BNI, Fortune 500) by his firm Berkshire Hathaway (BRKA, Fortune 500) an "all-in wager" on America.
And for what it's worth, retail investors over the past two decades have shown a tendency toward being too gloomy in the early stages of economic and market rebounds.
In a note to clients Monday morning, analysts at Al Frank Asset Management, a Laguna Beach, Calif.-based investing firm, pointed out that the only times since 1987 when the gap between bears and bulls in the AAII's weekly survey was higher than where it is now were during a few weeks in late 1990, early 2003 and last year.
Of course, market bears were dead-on a year ago. But anyone who wasn't invested in stocks during the 1990s or after the recession earlier this decade missed out on some huge rallies.
With that in mind, the analysts at Al Frank called the latest AAII sentiment numbers a "screaming buy signal" for anyone who likes to take a contrarian point of view.
Matt O'Reilly, chief investment strategist with People's United Wealth Management in Bridgeport, Conn., agreed. He added that he doesn't think investors are actually all that worried that the worst is yet to come.
O'Reilly said that because stocks have moved so dramatically in such a short period of time, more investors may be saying they are bearish because they want stocks to go down.
Average investors may be rooting for the markets to pull back because only then will they feel more comfortable buying again. They don't want history to repeat itself and get suckered into buying at what turns out to be another market top.
"Investors are fearful that they missed a nice rally off the bottom. Individuals are sitting at the edge waiting for an opportunity to jump back in," O'Reilly said.
He thinks these investors shouldn't wait too long, though. When everyone is doubting the rally, that's usually the time to buy.
"Confidence is a fragile thing. But historically, the more bearish that individual investors are, the more wrong they are as well," he said.