Stocktake: Hated bull market suggests stocks will continue to climb

Cautious investor sentiment indicates stocks will continue to climb the proverbial wall of worry, with no evidence of the feverish excitement associated with market tops.

Sentiment surveys carried out by Nobel economist Robert Shiller’s Yale International Centre for Finance find confidence among individual investors, as measured by the percentage believing stocks will be higher in a year’s time, is at an all-time low. Institutional investor confidence has also plunged in recent months.

Additionally, ordinary investors believe stocks are more expensive than any time since 2001. Market crash fears have also increased sharply in recent months, among both ordinary and professional investors, and are at their highest since 2011, when sovereign debt fears in Europe and the United States caused severe market turmoil.

The current environment is very different – the S&P 500 is hitting new all-time highs almost on a weekly basis, with every minor pullback turning out to be a buying opportunity.

Ordinarily, market strength seduces investors, leading to excessive bullishness.

That has yet to happen in the current cycle, which money manager Barry Ritholtz dubs the "most-hated bull market in history". As long as scepticism persists, stocks are likely to continue their long advance.

Oil – Apocalypse Now? Oil is in free fall, down almost 40 per cent after five consecutive monthly declines. Few, if any, foresaw the descent from above $110 to $70, but that hasn't stopped fortune tellers from asserting that $30 oil prices are coming.

Things were very different in 2008, when the oil bubble drove prices as high as $147.

Goldman Sachs told investors $200 oil was coming. Charles Maxwell, a “senior energy analyst” with Weeden & Co, was even more bullish. “We will see $300 a barrel . . . because oil supply will be so short. If you want that oil, that’s what you will have to pay for it.”

Well, no. Within months, oil had fallen below $34.

No one knows for certain where oil is headed today; it may well go much lower. However, remember that apocalyptic assessments typically follow rather than precede crashes, just as soaring prices tend to catalyse euphoric predictions. As Wall Street Journal columnist Jason Zweig says, "beware of extreme extrapolations".

Giving up on hedge funds The number of hedge fund closures is set to hit its highest level since 2009, Bloomberg reported last week, following another year of lousy returns.

On average, hedge funds have returned just 2 per cent this year. Stock hedge funds have advanced just 41 per cent since the end of 2008, compared to the S&P 500’s 153 per cent.

Obviously, many investors have lost patience, although hedge fund defenders see this as ill-advised. Hedge funds’ cautious approach has cost them, they say, but they will be rewarded when the current bull market eventually tumbles.

This misses the point, as their underperformance predates the current bull market. The standard 60:40 portfolio (60 per cent stocks, 40 per cent bonds) has beaten hedge funds every year since 2002.

Habitual underperformance is bad enough, but the fees – currently averaging 1.5 per cent of assets managed and 18 per cent of profits – are even worse.

There have been calls for reform, starting with a pledge that hedge funds beat benchmarks before charging incentive fees. If those calls are not heard, pension funds really should take their money elsewhere.

Inexperienced fund managers Few active fund managers outperform, and those that do rarely maintain their winning streak. That's reason enough not to chase performance, but here's another: fund managers don't stick around for long, Schroders' Nick Kirrage noted recently.

There are around 17,000 British funds, with roughly a third of managers having less than three years’ experience. Fund selectors often choose funds with a strong three-year performance, and yet many will presumably be headed by someone who had little or nothing to do with that outperformance.

Additionally, just a fifth of managers have ten years’ experience. Such low survival rates likely lead to index-hugging and consensus investing. “Unfortunately”, adds Mr Kirrage, “doing what is right by your investors is not always consistent with doing what might keep you in your job”.

Diversity may deflate bubbles

More ethnic diversity on trading floors may help prevent market bubbles, according to a new study.

For the study – entitled Ethnic diversity deflates price bubbles – participants were placed in a simulated trading environment.

Pricing accuracy was 58 per cent more accurate in diverse markets; in homogeneous markets, traders were more likely to agree with each other, even if assets were obviously overpriced.

The “mere presence” of minority traders “changed the tenor” of decision-making, creating a friction that can “disrupt conformity, interrupt taken-for-granted routines, and prevent herding”.

Promoting diversity is right in itself, say the authors, but the business community should realise it can also contribute to the bottom line.