Where did all the bears go?

Gosh, were we ever wrong. We were sure that the shut-the-government-down fiasco was due to be settled in a flash once the cry went up from an angry citizenry that if Uncle Sam was forced to hang out a "temporarily closed for business" shingle and paychecks would not be issued for nonessential federal employees, the withholding had better start with congressmen—or else. Man, you could see the pitchforks and the feathers and smell the tar.

If you can't depend on our chosen representatives to act like the greedy cowards they've proved themselves to be many a time and oft, invariably willing to chose principal over principle, what can a man count on? Yet here we are, the hours tick away, the deadline looms ever closer—and the squabble drags inexorably on.

Back at the end of February, we warned of the possibility that the government might be mothballed and pooh-poohed the comforting predictions by the sunshine crowd that it would never happen, and even if it did, the effect would be just about nil.

What was silly then is particularly ludicrous now, with the economy still fragile, the recovery powered largely by stimulus courtesy of Washington, the dollar weakening ignominiously, unemployment high and confidence shaky. Not to mention the enormous dislocation, confusion and concern sure to ensue should the government go AWOL.

Moreover, chances are that even a last-minute, Band-Aid agreement to keep the government operating for another week or two would only ensure a replay of the whole nasty wrangling and postpone the day of reckoning. As to the notion that a shutdown wouldn't affect Wall Street—tell that to the savvy folks who've been pushing the price of gold to all-time highs: they're pretty serious people and entitled to a chuckle or two.

WE'VE LONG FELT that had Sigmund Freud not been so obsessed with listening to his patients nestled on a couch telling him their woes, most of which they blamed on having chosen the wrong mom and pop and then compounding their grievous error by choosing the wrong spouse, he would have a been a great portfolio manager. For while it helps, we suppose, to be able to tell the difference between a balance sheet and an income statement and know what P/E stands for, nothing in the investment armamentarium beats an educated grasp of crowd psychology.

Granted, getting a handle on investor sentiment is not an automatic guarantee of making a killing on the Street. It's a contrarian indicator that has been around for a spell, and like a lot of venerable technical tools is a bit the worse for the wear. It's grounded in the logical assumption that when everyone's bullish, it implies that a lot of buying power has already been used up and, of course, when everyone's bearish, the opposite holds.

If not infallible (what is, as we've noted before, besides the pope and financial journalists?), it provides investors with a highly reliable litmus test when the market reaches extremes of optimism or pessimism. And, right now, bullishness is dangerously rampant.

Bulls in Command—for Now
The spread between bulls and bears is the highest since 2007.


For confirmation, just take a gander at that simple chart that enlivens this grim page, the handiwork of Investors Intelligence, which weekly tracks the view of those earnest souls, investment advisors, who tell you when, and often what, to buy and sell. It depicts the difference between the number of advisors who are upbeat and who are downbeat.

That awesome spread in favor of the bulls works out to 41.6%, the most lopsided since the October 2007 all-time market peak, when the comparable gap was 42.4% and set the stage for the beginnings—and forgive us for stirring painful memories—of the worst equity disasters of the past half century.

Nothing more graphically illustrates the panicky stampede for the exits by the bears than the shrinkage in the latest reported week in their ranks from 23.1% to 15.7% of the advisors surveyed. According to the folks at Bespoke Investment, in only 16 other weeks since 1975 have the bears thrown in the towel so precipitously.


And it isn't only the pros who are manifesting sharply rising exuberance: The investment masses, who've been more than a tad cautious of late, are venturing more boldly out of their cocoon. The latest report by the American Association of Individual Investors shows that 43.6% of its members were bulls, 28.8% bears and 27.6% on the fence. Barring a calamity that scares the dickens out of them, we'd expect many of those fence-sitters to clamber down to the bullish side just in time to catch the next market slide.

Richard Band, boss man at an advisory outfit called Profitable Investing, whom we don't know but stumbled upon via a quote while perusing the latest edition of Investors Intelligence, and who seems like a reasonable chap, offers investors some caveats beyond the preponderance of bulls, like extended valuations, insider selling and rather meager dividend yields, that are worth your mulling.

On overly generous valuations, he cites the Q Ratio, which compares a corporation's market cap with the replacement value of its assets. Currently, Band points out, except for a brief period at the end of the dot-com bubble, U.S. corporations are trading at a higher premium to the replacement value of their assets than at anytime in the past 110 years.

As to the stingy attitude managements have had toward sharing the piles of cash they've accumulated with shareholders, he notes that the present yield of 1.86% on the S&P 500 is only "an eyelash away from the 1.76% low set at the market top in 2007." Making him more than a little leery, too, is that, last time he looked, insider sales by the top dogs of Big Board and Amex companies were 10 times their purchases, prompting him to comment: "In my 30-odd years as an insider sleuth, I've never seen a figure that high."

All of which makes him think "the party is slowly winding down," though he reckons the bull market still has four to six months left before it goes kaput. Here we part company. We feel—you'll never guess, we're sure—he's too hopeful.

ALTHOUGH IT'S A CLOSE CALL, we do, as implied at the top of this screed, favor a dysfunctional government, with all its sins, over a non-functioning government. But suppose the choice is between a dysfunctional central bank versus a non-functioning central bank? Well, (and pace, Ben, this doesn't concern you) if we lived in the European Union, we'd choose the non-functioning version in a heartbeat.

What prompts this irascible judgment is last week's boost in the European Central Bank's benchmark interest rate by 0.25 of a percentage point. In itself, that's not the end of the world, but the scuttlebutt has it that it's only the first in a series of similar hikes. And perhaps the best guarantee that more of the same is in the offing is the denial by Jean-Claude Trichet, the ECB's president, that he and his cohorts have decided to become serial rate boosters.

The bank's switch to tightening presumably is occasioned by Trichet's concerns about inflation. Michael Darda, chief economist and market strategist at MKM Partners, isn't buying it, and neither are we. Or, at the very least, inflation doesn't stack up as all that immediately threatening. Of course, to judge by some of his past actions, Mr. Trichet doesn't possess a great nose for inflation. Back in July 2008 and after the recession hit the euro zone and just before Lehman did its swan dive, he raised rates. Exquisite timing.

And Trichet may yet regret hiking rates last week. Here, too, his timing may be more than a little off. Last week's increase, Michael observes, has inverted the spread between GDP and the ECB target rate, in the process "dramatically increasing the risk of more debt trauma in the periphery and a hard-landing scenario for the euro zone as a whole." Not a pretty prospect.

We don't want to pick on Trichet, but we will anyway. For he appears to be auditioning for the role of the Don Quixote of central bankers, attacking the phantom windmills of inflation. The irony of Trichet's move, in Michael's view, as expressed in a commentary bearing the headline of "Accommodation or Suffocation," is that the liquidity backdrop in Europe suggests monetary policy is much tighter than it was in the summer of 2008, despite the fact that real rates are lower. Indeed, the ECB's balance sheet is now contracting on a year-over-year basis, and broad money is growing at less than the rate of inflation.

"Sadly," Michael reflects, "the ECB appears to be headed down the path forged by the Bank of Japan over the better part of the last two decades: confusing low rates with easy money and blaming weakness in the monetary aggregates and nominal GDP on structural factors beyond its control."

Ah well, central bankers have a penchant for making bad things worse.