Late In The Market's Advance But Not The End?

This week's market chart from Chart of the Day is suggestive of a further market advance if history is any guide. Chart of the Day states:

"Today's chart illustrates rallies that followed massive bear markets. For today's chart, a 'massive' bear market is defined as a decline of greater than 50%. Since the Dow's inception in 1896, there have been only three bear markets whereby the Dow declined more than 50% (early 1930s, late 1930s until early 1940s, and during the recent financial crisis). Today's chart also adds the rally that followed the dot-com bust during which the Nasdaq declined 78%. The current Dow rally has followed the post dot-com bust rally of the Nasdaq that began back in 2002 fairly closely and held to a general post-massive bear market rally pattern -- rally during the first 300 trading days, trade in a relatively flat choppy manner up until around 600 trading days and then re-embark on the second leg of the rally. History may not repeat, but it rhymes."

From The Blog of HORAN Capital Advisors

Source: Chart of the Day

Bonds Continue To Deliver Painful Results For Investors

Much has been made about investors turning on the equity buying spigot since the beginning of the year. As the below chart shows, however, investors appear to be allocating as much of their investment dollars to bonds as they are to stocks. As noted in earlier posts, this allocation decision seems to be based on investors redeploying cash that was held taken out of the market in the run up to the presidential election and the fiscal cliff.

From The Blog of HORAN Capital Advisors

The downside to this allocation decision has been investors are getting a clear view of the negative returns that can be generated by bond investments as interest rates rise. Since the election, the 10-year Treasury yield is up nearly 50 basis points and the below chart details the loss in principal value that has occurred compared to the return generated by the S&P 500 Index.

From The Blog of HORAN Capital Advisors

Confirmation Bias Dangers And Apple

One of the most damaging psychological phenomenons for investors is confirmation bias. In the world of science confirmation bias is most commonly defined as:

"A phenomenon wherein decision makers have been shown to actively seek out and assign more weight to evidence that confirms their hypothesis, and ignore or underweigh evidence that could disconfirm their hypothesis (ScienceDaily)."

The excellent website, Abnormal Returns, recently highlighted how investors have been harmed by the recent price action of Apple (AAPL), much of the harm attributable to confirmation bias. Two of the articles Abnormal Returns references focuses on the role greed plays in confirming the validity of the confirmation bias phenomenon.

• The Rise and Fall of Andy Zaky: Apple 2.0. In this Fortune magazine article, the story describes how investors recently made increasingly risky bets on Apple convinced that Apple stock was only going to move higher. The result has been investors have lost millions of dollars on their wrong "bets".

• Greed + Confirmation Bias = Disaster. This article provides some insight on what investors should do in order to minimize the negative impact of confirmation bias. The article's main summary for investors in order to avoid confirmation bias is:

"When you’re in a trade or an investment, you should be more eager to hear from the people who disagree with your thesis than from the people who agree with your thesis."

For investors then, seeking out views the are contrary to ones investment bias is usually an important strategy that can lead one to avoiding substantial investment losses.

Sentiment And Fund Flows In Perspective

Since shortly after the election in November last year, the market (S&P 500 Index) has moved higher by over 11%. This move has confounded some as the year end fiscal cliff was around the corner and could have certainly derail further market advances. As I wrote in September in answer to a client's question regarding the market, polls were projecting an Obama win and expectations were Congress would let the country go over the cliff. If the cliff was averted, I noted this could be positive for the market as the market was expecting worse.

I have noted in several earlier posts about investors allocating more of their investment dollars to fixed income or bond investments versus stocks over the last four years. This has occur in spite of the fact stocks have been a far better performer than bonds during this time frame. So far this year though the financial media has noted that investors have poured record amounts of investment funds into stocks. My first thought is investors are now buying stocks after a four year period when stocks have outperformed bonds. One potential concern as it relates to individual investor sentiment is they tend to make incorrect investment calls at market turning points. So are we really seeing investors choosing stocks over bonds now?

As the blue line in the below chart shows, equity fund flows did turn positive in January. However, the bond fund flows (green line) is also positive. What appears to be occurring is investors simply moving out of cash and into both stocks and bonds.

From The Blog of HORAN Capital Advisors

It does seem investor skittishness remains high as well. In last week's American Association of Individual Investor sentiment survey, it was noted that bullish sentiment fell 13.4 points to 28.4%. This lower level of bullish sentiment is one standard deviation from the longer term average. This also resulted in the bull/bear spread equaling a negative 8.2 percentage points. Investor sentiment does tend to be most accurate at extreme levels.

From The Blog of HORAN Capital Advisors

Lipper also reported last week,

"There was one big change, however, equity mutual funds and equity ETFs as a group suffered their first week of net redemptions in the last ten weeks, as investors took some of their hard-won profits off the table out of fear that they might be in jeopardy in a deteriorating investment climate. All told, these investors pulled a net $900 million out of stock mutual funds and ETFs, although they injected $4 billion of new capital into taxable bond funds as well as $300 million into municipal bond funds (their ninth straight week of net inflows) and $3.6 billion into money market funds, a traditional safe haven in times of volatility or anxiety...The most recent weekly period was the first time in eight weeks that equity ETFs experienced net outflows, as investors pulled out some $3.8 billion."

At the end of the day investors do not seem overly bullish (actually far from it) and they do seem under invested in equities as a whole due to a cautious positioning ahead of the election and fiscal cliff. So long as companies can deliver on earnings and Washington actions (or inaction) do not derail the economy, the market could grind higher near term although it will likely be volatile. An important near term resistance level is the 2/19 S&P close of 1,530.